Category Archives: Energy

Beyond Neoliberal Energy – A Thought Experiment

This is a follow-up to my previous post in response to the IEEFA report on the $10bn supernormal profits reaped by energy network providers within the National Energy Market. In that post I suggested that neoliberal ideal of energy provision via the regulation of monopoly energy transmission and distribution networks reflected neoclassical economic orthodoxy. Other schools of economic thought would give rise to different approaches to regulating the energy market, with different methods of analysing returns on investment and hopefully different outcomes of revenue and pricing determinations.

However, all that discussion was still within the parameters of a regulated market. The commentary was relevant (though slightly different) regardless of whether the monopoly owner of the network was publicly or privately owned. In this post, I want to extend the analysis, not with further economic theory, but with a thought-experiment going beyond neoliberal energy frameworks.

Imagine if energy transmission and distribution was delivered the way we provide most school education – by a government department with a goal of service provision rather than profit. This is not simply government ownership of a business enterprise (though who owns and reaps the profits of such enterprises is an important question), but rather de-commodifying energy transmission and distribution.

Imagine a government department running the network. It might be the same engineers, tradespeople and staff providing the service, but without the same need for value-capture (and the restrictions and investments that that requires). Each year (or five) the department would put up budget bids for government funding of new infrastructure required to maintain, upgrade or expand the network (much as the current network providers put proposals to the AER).

The energy network would be paid for by a (hopefully still) progressive tax system, rather than the current customer base which sees disproportionate impacts on poorer households.

Imagine – I wonder if you can?

Of course, such a proposal of government provision of energy would bring howls of “inefficiency!” from neoclassical economists, right-wing pundits and those who simply can’t imagine any other options beyond neoliberalism (which incidentally has delivered economic growth rates over the last 30 years well below those of pre-neoliberal period – but that is another story).

However, as I noted in my previous post, the current regulatory regime does not and cannot imitate market disciplines and alleged efficiencies. But even if it did reflect a real market, would the alleged “market efficiencies” make up for the $25bn of profit/costs (including $10bn “above the reasonable costs”) quantified in the IEEFA report?

That is an empirical question. Any claim of public inefficiency without an analysis of relative in/efficiencies is simply ideology and/or vested interest.

Doubtless though, at the thought of a government department providing energy network services, energy system analysts would also tell us the electricity grid and economics is all very technical and complicated, and too important for pricing and investment decisions to be left to government departments and politicians without the expertise or discipline of the market.

Granted, politicians do have limited time-horizons by virtue of our electoral cycle, and the mathematical models for determining costs and revenue are truly complex. But at the base level, is the flow of electrons down a wire really more complicated than the development of the human mind, with all the complexities of childhood learning and social contexts? The education of the next generation is certainly no less important than the provision of energy. Yet the market is an attachment (and often a parasitic attachment) to the education system in Australia. It is not its centrepiece and regulatory mechanism.

In Governomics, an excellent book published a few years ago, Ian McAuley and Miriam Lyons set out arguments and criteria for when a good or service is best provided by public service provision, and when best provided in the market. On their criteria, as a natural monopoly it is a no-brainer that energy networks should not be privatised. However, as energy is a saleable commodity, even where public ownership has been retained the default has been to a government-owned business model – publicly-owned corporations mimicking private corporations selling to retailers or consumers. The same model was adopted for the NBN, for the same reasons.

But my thought experiment here challenges us to leave the market and neoliberal energy behind altogether. It is hard, because we have been so socialised into neoliberal ways of thinking, we are losing the ability to think of different possibilities. And yet, direct government service provision is how we provide much large-scale education, health and other services.

Of course, the universal government provision of energy is not going to happen in the foreseeable future – although in a SACOSS submission to a parliamentary committee, I did argue for an iterative approach of government investment in new energy initiatives. And there are hopeful signs here. The previous Labor government in South Australia brought new emergency energy production online via publicly-owned generators (although later sold off), but on a much bigger scale we have just seen the Federal, Victorian and Tasmanian governments announce public funding for a huge new electricity transmission project across the Bass Strait, albeit through a publicly-owned corporate entity model.

More importantly though in the context of this argument, even to contemplate government provision opens a new window on the current neoliberal energy model which is failing on so many fronts. Profits from energy transmission and distribution are ripped out of the system (and the country), environmental impacts remain an externality, equity and social justice outcomes are morphed into narrow consumer rights issues, prices are increasing, and those who can afford to are bailing out via solar and non-grid options.

We need to imagine alternatives.

Blowing the Whistle on Energy Network Supernormal Profits

A recent report by the Institute for Energy Economics and Financial Analysis (IEEFA) blows the whistle on energy network owners in Australia who have reaped $10bn in supernormal profits from 2014 to 2021. “Supernormal” profit refers to the profit made over and above the return on investment the energy regulator determined was necessary to provide reliable electricity network services.

Context

Energy network service providers are the companies (public and private) who get electricity or gas from its point of production to consumers. In most states they operate in the National Energy Market, a governing mechanism established by legislation at the height of neoliberal faith in the market. However, these transmission and distribution networks are natural monopolies (as it is inefficient to duplicate expensive network infrastructure). To ensure that they do not exert unfair pricing power, the Australian Energy Regulator (AER) regulates and must approve the total revenue that the network providers can receive. This revenue amount is set in a complex determination process that is meant to ensure that networks charge consumers only what is required to cover the costs of investing in, building, maintaining and operating the networks, plus a reasonable profit to ensure compensation for investors.

Sources of Supernormal Profits

The IEEFE report analyses the difference between the profits built in to the regulatory determinations and the actual profits made by electricity network providers (gas network data was not available). The following graph from the report summarises the key contributions to these “supernormal profits”.

Graph showing $15bn normal profits and $10bn supernormal profits, from $1.9bn gearing, $3.5bn interest rates, $1.1bn Opex, $1.2bn Capex, $0.5bn tax, $0.7bn other.
Source: Simon Orme, “Regulated Electricity Network Prices are Higher than Necessary“, Institute for Energy Economics and Financial Analysis, October 2022.

As can be seen, the biggest single factor was interest rates, where companies were able to source finance at below the interest rates factored into the regulatory model. (This was not just falling rates, but also some dubious assumptions about risk and credit ratings). However, the system also allowed for supernormal profits arising from “gearing” different mixes of debt and equity finance (with different rates of return), as well as under-spending on operating and capital expenditures and, in the early years, paying significantly less tax than was factored into the regulatory model.

The issue that has caused most controversy is the profits from incentive schemes to reward savings made from productivity improvements. The report suggests the regulatory model is overly generous in the proportion of productivity improvements allowed to be retained as profit. I don’t have a view on this, but simply note that even if the profit retained is reasonable and not “supernormal”, it only accounts for 15% of the supernormal profits identified in the report.

Implications of Supernormal Profits for Equality

The IEEFA report focuses on the implications of supernormal profits on electricity prices for consumers, and whether the regulator is fulfilling its key objective to ensure “consumers pay no more than necessary for the safe delivery of reliable electricity and gas network services”. While this is important, my interests are a bit different.

It is well-established that energy expenditure is regressive, that is, energy accounts for a greater proportion of the expenditure of low-income households than of those with higher incomes. Accordingly, the supernormal profits reaped from inflated consumer prices represent an economic flow from consumers to capital, with disproportionate impacts on low-income consumers. Where energy networks are private companies, the owners of that capital will be wealthier people – meaning that money is being syphoned from the poor to the rich. Even in the case of government-owned utilities, this flow of supernormal profits is the equivalent of a regressive tax borne disproportionately by the poor – the sorts of taxes usually opposed by those interested in equality.

Solutions and Limitations

Given these implications, this is a really welcome report – more so because the issue of profit-taking is largely ignored in energy debates dominated by prices, reliability and emissions.

Inevitably, energy market insiders with interests to protect will attack the report (often on technical detail without addressing the key question of whether the actually achieved profit-levels are acceptable). Equally inevitably, regulators will to try to ignore or resist the report’s conclusions.

However, despite that, the report itself is fairly conservative. It is very much a critique from within the system. It accepts most of the neoliberal framework of the purpose and role of the national energy market and is simply concerned with how that is being done. Indeed, the author, energy consultant Simon Orme, and presumably the IEEFA, accept some level of supernormal profit above the regulated rate, but believe that the current magnitude is unacceptable.

Further, in response to my questioning, the author and IEEFA did not believe a change to include social equity as one of the legislated objectives of the market regulation was needed, despite regressive impacts identified above. This was based on a confidence in the effectiveness of the technical proposals put forward. Yet even if that were true in theory, I am not sure that changes which would cost dominant market players millions of dollars will happen without political pressure. And in this context, a requirement for the regulator to take account of social equity outcomes would add to the arguments to implement the very technical fixes the report is calling for.

A market which operates without political context or interference, and where social outcomes are externalities beyond market logic (and regulation), is a hallmark (and failing) of neoliberalism, but perhaps the most obvious place where the theoretical framework underlies and limits the report’s analysis is in the theory and categorisation of profit.

Theory of Profit

The IEEFA report utilises a neoclassical theory[1] of profit as a cost of production, one cost among many factored into the market supply price. This is orthodox microeconomics based on an idealised market, and it is the logic behind how the national energy market is set up. The report works within this paradigm, but simply disagrees with the amount of the profit.

However, there are different schools of economic thought which start from premises other than a perfect market. As I understand it, Kalecki and Post-Keynesians incorporate monopoly and imperfect competition into theories of profit – arriving at some form of higher-than-perfect rate of profit as “normal”. That suggests to me that when the AER benchmarks energy networks’ rates of return on investment using the standard returns of energy or other uncompetitive industries (rather than an economy-wide normal rate of return), it incorporates a monopoly mark-up into its regulated rate of return. Accordingly, even energy network “normal” profit includes some economic rent above “reasonable costs”.

From a different perspective, classical political economy views profit in a capitalist economy as the purpose of production rather than a cost, and it is an appropriation of income after the fact of production, not a cost in the process of production. Investment decisions are based on expectations of profit (rather than actual profit – although there is a messy interaction between expectations and reality), but profit is not guaranteed and the rate of return on investment is inevitably contested in power struggles between capital and labour, and in real competition in the market (see Anwar Shaikh’s monumental reframe of classical economics).

One thing to draw from this is that the regulated a priori rate of return for energy network providers does not and cannot replicate market processes, disciplines and efficiencies. Indeed, where any approved investment is guaranteed a profit, there is an incentive to over-invest as investment size rather than efficiency/effectiveness becomes the base for earning profit. Even a regulator’s most technically proficient calculation of a market rate of return is based on a false premise.

However, a broader point can also be drawn from the classical tradition. If profit is by definition a capture of revenue that has been generated by production, rather than a cost of that production, then the arguments above about the regressive impacts of supernormal energy profits also apply to “normal” profits. They too are a flow of funds from consumers to capital (or in the case of publicly-owned utilities, to a government revenue stream) which places a disproportionate burden on the poor.

In summary, while the magnitude of the flow of profits is important, the Kaleckian and Post-Keynesian theories question the distinction of normal and supernormal profits in practice, and classical political economy suggests it is unnecessary in theory – and also arguably unhelpful in practice as it hides a key dynamic of the “normal” operation of the system.

Conclusion

Of course, in a capitalist economy, profit is required (though not guaranteed) as without it there would be no investment and production – no capitalism. This inevitably means there will be flows of income to those who own capital wealth. It is simply the price of capitalist production and in this context, the extraction of profit from energy transmission and distribution is not a surprise.

However, the differences in the various economic theories remind us that even a privatised monopoly could be regulated with a different set of assumptions and possibly different outcomes. What that might look like in the national energy market is beyond both my competence and the scope of this post, but once we move beyond the framework of neoliberalism and neoclassical economics, we open up alternatives to a model which is fundamentally failing – in ways beyond simply supernormal profit-making.

In that sense, while the IEEFA report is really useful in focusing on and quantifying profit-levels, it is also limited in its ambition and framework.

[1]              To be clear on definitions, by neoclassical economics, I am referring to the body of orthodox economics stemming from the work of Marshall, Jevons and Walras in the late 19th and early 20th century (Thesis Ch 1) and which proceeds from a founding assumption of autonomous rational actors in a perfect market. Neoliberalism is the political project which attempts to actively apply that market logic to understandings of economic policy, the state and society.