1998
 
 

_______________________
 
 

PARLIAMENT OF TASMANIA

_______________________
 
 
 
 
 
 

PARLIAMENTARY STANDING COMMITTEE OF PUBLIC ACCOUNTS
 
 
 
 
 
 
 
 
 
 
 

DISAGGREGATION OF THE HYDRO-ELECTRIC CORPORATION AND OTHER RELATED MATTERS
 
 
 
 
 
 
 
 
 

INTERIM REPORT ON DISAGGREGATION
 
 

_________________________________________
 
 

Laid upon the Tables of both Houses of Parliament

___________________________
 
 

The Committee was appointed under the provisions of section 2 of the Public Accounts

Committee Act 1970 (No 54)


 

















Preface
 
 

In presenting this interim report, the Public Accounts Committee has endeavoured to meet its obligation of providing comprehensive information to the Parliament and the people of Tasmania to inform future debate.
 
 

The report takes into consideration evidence gathered from 87 documents, many substantial and complex reports, 10 submissions and representation made by 44 witnesses. It provides details of important and relevant background information as context for the reader.
 
 

As an interim report, the report focuses on the matter of disaggregation and only deals with the matters of the sale/lease of the transmission and distribution/retail businesses of the HEC and the proposed development of Basslink as they relate directly to the debate about disaggregation. Detailed consideration of sale/lease and Basslink has been reserved for subsequent reports.
 
 

Whilst the Committee has drawn out a set of findings and conclusions on the key issues, it has limited its recommendations about the appropriate structure for the disaggregated transmission and distribution/retail businesses because the choice of option hinges on whether the sale/lease of these businesses is appropriate and whether Basslink is viable and appropriate.

The findings, conclusions and recommendations presented in this report must not be considered to pre-empt those that may be made in subsequent reports.
 
 
 
 

Table of Contents
 
 

PREFACE
 
 

SUMMARY OF FINDINGS
 
 

conclusions and recommendations
 
 

Chapter 1 - Introduction *

1.1 Background *
 
 

1.2 Issues Underpinning the Reference *
 
 

1.3 The Committee’s Terms of Reference *
 
 

1.4 Collection and Evaluation of Evidence *
 
 

1.5 Interim Report on Disaggregation *
 
 
 
 

 Chapter 2 - Overview of Electricity Reform in Australia * 2.1 COAG’s Electricity Reform Agenda *
 
 

2.2 The National Electricity Market *
 
 

2.3 National Competition Policy Reform *
 
 

2.4 State and Territory Progress in Reform *

2.4.1 Market Development *

2.4.2 Structural Reform *
 
 

 2.5 Tasmania’s Progress in Reform * 2.5.1 Commitments under NCP and COAG Agreements *

2.5.2 Legislative Reform *

2.5.3 Disaggregation of the HEC *

2.5.4 The Government’s Plans for Further Reform *
 
 
 
 

 Chapter 3 - The Rationale for Electricity Reform in Tasmania *
 
  3.1 The Problems and Reform Issues * 3.1.1 Obligations under the NCP and COAG Agreements *

3.1.2 Business Imperatives for the Hydro-Electric Corporation *

3.1.3 The State’s Economic and Fiscal Position *

3.1.4 Future energy supply and risk management *
 
 

 3.2 The Proposed Solutions * 3.2.1 The Government’s Position *

3.2.2 The Outcomes Sought *

3.2.3 Alternative Solutions Proposed *
 
 

 3.3 The Relationship Between Disaggregation, Sale/Lease and New Supply Options *
 

Chapter 4 - Structural Approaches to Disaggregation *
 
 

4.1 The Current Structure of the HEC and its Operation as a Vertically Integrated Monopoly *
  4.2 What is Disaggregation? * 4.2.1 Vertical and Horizontal Disaggregation *

4.2.1 The Corporate Structures for Disaggregated Units *
 
 

 4.3 The Scope of Disaggregation * 4.3.1 Generation *

4.3.2 Transmission *

4.3.3 Distribution and Retail *

4.3.4 Other Observations *
 
 

 4.4 Comparison of Corporate Structures * 4.4.1 Operational Characteristics *

4.4.2 Issues Relating to the Disposal of assets/businesses *

4.4.3 Establishment phase for structure with existing assets in HEC *
 
 

 Chapter 5 - Rationale for the Disaggregation of the HEC * 5.1 The obligations of NCP and COAG agreements * 5.1.1 The Need to Disaggregate *

5.1.2 The Appropriate Corporate Structure *

5.1.3 Timing Issues *
 
 

 5.2 The Development of Competition in the ESI * 5.2.1 The Need to Disaggregate *

5.2.2 The Appropriate Corporate Structure *

5.2.3 Timing Issues *
 
 

 5.3 Business Imperatives for the Hydro-Electric Corporation * 5.3.1 The Need to Disaggregate *

5.3.2 The Appropriate Corporate Structure *

5.3.3 Timing Issues *
 
 

 5.4 The proposed entry of Tasmania to the NEM * 5.4.1 The Need to Disaggregate *

5.4.2 The Appropriate Corporate Structure *

5.4.3 Timing Issues *
 
 
 
 
 
 

 5.5 The Need for Certainty on the Part of Basslink Investors * 5.5.1 The Need to Disaggregate *

5.5.2 The Appropriate Corporate Structure *

5.5.3 Timing Issues *
 
 

 5.6 Sale/Lease of the Transmission and Retail/Distribution Businesses * 5.6.1 The Need to Disaggregate *

5.6.2 The Appropriate Corporate Structure *

5.6.3 Timing Issues *
 
 

 5.7 Summary Comparison *
 
 

5.8 The Costs and Benefits of Disaggregation and Impact on the Consolidated Fund *

5.8.1 The Costs and Benefits of Disaggregation *

5.8.3 The Impacts of Disaggregation on the Consolidated Fund *
 
 

 5.9 The Impact of Disaggregation on Contractual Obligations *
 
 

5.10 The Impacts of Disaggregation on Employment *
 
 

5.11 Consumer Impacts from Disaggregation *
 
 

5.12 Conclusions and Recommendations *
 
 
 
 

 GLOSSARY
 
 
 
 

APPENDICES
 
 

APPENDIX 1 LIST OF DOCUMENTS TAKEN INTO EVIDENCE
 
 

APPENDIX 2 LIST OF SUBMISSIONS
 
 

APPENDIX 3 LIST OF WITNESSES
 
 
 
 

Summary of Findings
 
 

Finding 1 (Section 4.3.1, p.32)
 
 

The Committee believes at this stage that formation of a single generation business is appropriate, but it has not ruled out consideration of horizontal disaggregation at a later stage.
 
 
 
 

Finding 2 (Section 4.3.2, p.32)
 
 

The Committee concluded that formation of a single transmission business is appropriate.
 
 
 
 

Finding 3 (Section 4.3.4, p.34)
 
 

The Committee noted:
 
  The Committee noted the NCC Secretariat’s views on the separation of the distribution and retail businesses.
 
 

The Committee considered that, provided the Government is able to demonstrate that there is a clear public interest in retaining an integrated distribution/retail entity upon introduction of the retail market, there should be no impediment to doing so.
 
 
 
 

Finding 4 (Section 5.1.1, p.43)
 
 

The Committee found that:
 
 
 
 
 
 
 
  Finding 5 (Section 5.1.2, p.43)
 
 
 
 
  Finding 6 (Section 5.1.2, p.44)
 
 

The Committee concluded that:
 
 
 
  Finding 7 (Section 5.1.3, p.45)
 
 

The Committee found that, outside NEM connection, there were no specific obligations under the NCC and COAG Agreements in respect of the timing of disaggregation.
 
 
 
 
 
 

Finding 8 (Section 5.2.1, p.48)
 
 

The Committee found that:
 
 
 
  Finding 9 (Section 5.2.2, p.49)
 
 

The Committee noted that:
 
 
 
  Finding 10 (Section 5.2.3, p.49)
 
 

The Committee found that there was some evidence to suggest that the sooner disaggregation is achieved the sooner some competition can be introduced into elements of the Tasmanian ESI.

competition can be introduced into the ESI, however minimal it might be initially.
 
 
 
 

Finding 11 (Section 5.3.1, p.51)
 
 

The Committee found that the strongcurrent imperatives to disaggregate the HEC include:
 
 
 
  Finding 12 (Section 5.3.2, p.52)
 
 

The Committee found that:

 The Committee formed the view that either structure had the potential to yield efficiency gains and reduced monopoly power in comparison to the current HEC structure but that separate companies had the potential to yield greater gains in this sense than did subsidiaries.
 
 
 
  Finding 13 (Section 5.3.3, p.52)
  The Committee considers that if the Parliament supports the process of disaggregation then the process of company formation should continue in line with the HEC timetable, which seeks to establish the companies to commence from 1 July 1998.
 
 
 
 
 
 

Finding 14 (Section 5.4.1, p.54)
 
 

The Committee found that:
 
 
 
  Finding 15 (Section 5.4.2, p.55)
 
 

The Committee concluded that operators in the NEM are structured as both GBE and privately owned company models. The use of either separate company or separate GBE models for Tasmania is a matter of choice.
 
 
 
 
 
 

Finding 16 (Section 5.4.3, p.55)
 
 

Evidence indicated that a reasonable lead-time is necessary to allow entities to prepare for competition in the NEM. It is suggested that around two years prior to connection would be an appropriate period.
 
 
 
 
 
 

Finding 17 (Section 5.5.1, p.56)
 
 

The Committee acknowledged the Government’s view that investors working on a major investment require certainty on the system in which they would have to work. There areFailure to disaggregate which a developer may be seen by an investor as an obstacle to committing funds.

, in particular, the issue of disaggregation
 
 
 
 

Finding 18 (Section 5.5.2, p.57)
 
 

The Committee concluded in providing certainty for potential Basslink investors that:
 
 
 
  Finding 19 (Section 5.5.3, p.57)
 
 

The Committee considers that the early action to form the newdisaggregate would be important company to facilitate genuine expressions of interest in the development of the Basslink project.
 
 
 
 
 
 

Finding 20 (Section 5.6.2, p.59)
 
 

The Committee found that the disaggregation of electricity assets to form separate businesses was an essential prerequisite to sale.
 
 
 
 
 
 

Finding 21 (Section 5.6.3, p.59)
 
 

The Committee found that the Government’s current timetable would require prompt action on disaggregation given the plan to introduce legislation to progress the sale or lease later in 1998.
 
 
 
 
 
 

Finding 22 (Section 5.8.1, p.63)
 
 

The Committee found that:
 
 
 
  Finding 23 (Section 5.8.2, p.63)
 
 

Disaggregation provides for potential efficiency gains and improved business focus leading to cost reductions and new business opportunities that may offset the additional costs.
 
 
 
 
 
 

Finding 24 (Section 5.8.3, p.65)
 
 

The Committee concluded that disaggregation is unlikely to have a significant effect on the Consolidated Fund.
 
 
 
 
 
 

Finding 25 (Section 5.9, p.66)
 
 

The Committee considers that the Government must ensure that contracts to supply electricity and other services which have anti-competitive components must be transparent and demonstrably in the public interest.
 
 

The Committee concluded that, in disaggregation, changes to contractual arrangements will need to be managed to minimise financial risk.
 
 
 
 
 
 

Finding 26 (Section 5.10, p.68)
 
 

The Committee concluded that the management of the disaggregation process must take significant account of human resource management to minimise skill loss.
 
 

The Committee concluded that, following the disaggregation process, efficiency improvement is likely to result in reductions in employment levels. However, it was recognised that the subsequent proposals for sale or lease could have more significant employment impacts.
 
 
 
 
 
 

Finding 27 (Section 5.11, p.69)
 
 

The process of disaggregation is not likely to create particular consumer impacts. However, in any intermediate phase between disaggregation and sale/lease where a business is being prepared for sale/lease whilst in public ownership, its performance in relation to consumer issues such as disconnections should be monitored to ensure no significant negative impacts occur.
 
 
 
 
 
 

 Conclusions and Recommendations
 
 
 
 

It must be noted that this is an interim report about disaggregation and the Committee has not yet completed its deliberations about the sale/lease of the transmission and distribution/retail businesses and the proposed development of Basslink. As such, the findings, conclusions and recommendations presented must not be considered to pre-empt those that may be made in subsequent reports.
 
 

The Committee recommends that the HEC be disaggregated into three separate businesses:
 
 

The Committee concluded that disaggregation is unlikely to have a significant effect on the Consolidated Fund.
 
 

The Committee concluded that a number of factors indicate that there are significant impediments to the development of competition in both the generation and retail sectors of the Tasmanian electricity supply industry. These include:
 
 

The Committee concluded that these factors would prevail regardless of whether the businesses are operated in public or private ownership.
 
 

The Committee concluded, however, that disaggregation is the first step to the introduction of contestability and subsequent competition in the generation and retail sectors.
 
 

The Committee, in recommending disaggregation as a first step to the introduction of competition, recommends that significant effort be applied in preparing further strategies to enable the development of competition in the generation and retail sectors of the Tasmanian electricity supply industry.
 
 

The Committee concluded that the preferred corporate structure for each business is dependent on the outcome/s sought through disaggregation. The options are summarised in the following table.
 
 
 
 
 
 

OUTCOME SOUGHT: FUTURE DEVELOPMENT OF ELECTRICITY SUPPLY INDUSTRY IN TASMANIA

(in isolation from NEM interconnection and equity withdrawal)
 
 
 
 
 
outcome sought corporate structure options

for transmission and distribution/retail businesses

 is disaggregation recommended? benefits/considerations time considerations

 
FUTURE DEVELOPMENT OF ELECTRICITY SUPPLY INDUSTRY IN TASMANIA

(in isolation from NEM interconnection and equity withdrawal)

 Wholly Government owned private companies established under the Electricity Companies Act 1997.
 
 

 

 Yes
  • Consistent with model proposed by Government. 
  • Can be rapidly implemented given legislation already in place. 
  • Provides complete separation of business elements. 
  • Clear capacity to meet NCP obligations. 
  • Accountable to Parliament through the Memorandum and Articles of Association of the companies.
  • Legislation for disaggregation in place through Electricity Companies Act 1997. 
  • Disaggregation can continue consistent with HEC’s current timeframe of 1 July 1998 for start of new businesses.
 
Separate GBEs

 

 Yes
  • Consistent with existing GBE structures. 
  • Provides complete separation of business elements. 
  • Able to comply with all NCP requirements. 
  • Currently accountable to Parliament.
  • New legislation required.
 
Subsidiaries of existing HEC

 

 Yes
  • Enables smooth transition to disaggregated structure for HEC. 
  • Does not provide for complete separation of business elements - remaining connection between businesses through HEC Board. 
  • Potentially fulfils COAG/NCP obligations in isolation from NEM but not fully tested. 
  • Simplifies accounting transition for HEC. 
  • Allows maximum flexibility to Government to vary structure in the future. 
  • Originally HEC preferred position but later changed.
  • No new legislation required.
  • Can be implemented for 1 July 1998 start based on previous HEC view

 
 
 

OUTCOME SOUGHT: DEVELOPMENT OF BASSLINK AND NEM INTERCONNECTION
 
 
 
 
 
outcome sought corporate structure options for transmission and distribution/retail businesses is disaggregation recommended? benefits/considerations time considerations

 
DEVELOPMENT OF BASSLINK AND NEM INTERCONNECTION Wholly Government owned private companies established under the Electricity Companies Act 1997.

 

 Yes
  • Fully complies with COAG/NCP obligations. 
  • Well recognised corporate structure. 
  • Consistent with models in other States involved in NEM. 
  • Distribution/Retail structure not fully resolved with NCC.
 
  • Legislation for disaggregation in place through Electricity Companies Act 1997. 
  • Entry currently proposed for 2001-2002 with lead-time for investor commitment and development. 
  • Disaggregation timing is not critical but consistent with HEC’s current timeframe of 1 July 1998.
 
Separate GBEs

 

 Yes
  • Potentially complies with COAG/NCP obligations but not fully tested. 
  • Well established model in Tasmania. 
  • Comparable to models in other states involved in NEM. 
  • Distribution/Retail structure not fully resolved with NCC.
 
  • New legislation required. 
  • Entry currently proposed for 2001-2002 with lead-time for investor commitment and development. 
  • Disaggregation timing is not critical but consistent with HEC’s current timeframe of 1 July 1998.
 
Subsidiaries of existing HEC Yes
  • Does not comply with COAG and NCP obligations for NEM. 
  • Could be considered for interim step. Cannot be recommended in longer term.
 
  • No new legislation required.
  • Acceptable prior to entry to the NEM.

 
 
 

OUTCOME SOUGHT: EQUITY WITHDRAWAL VIA LEASE OR SALE
 
 
 
 
 
outcome soughtcorporate structure options for transmission and distribution/retail businessesis disaggregation recommended? benefits/considerations time considerations

 
EQUITY WITHDRAWAL VIA LEASE OR SALE Wholly Government owned private companies established under the Electricity Companies Act 1997.
 
 
 
 

 

 Yes
  • Maximises value for sale. 
  • Preferred structure in consultant’s work. 
  • Model is well understood in marketplace. 
  • Ensures separation risk is minimised. 
  • Not tested for lease.
 
  • Legislation for disaggregation in place through Electricity Companies Act 1997. 
  • Requires a minimum six months’ trading results for "due diligence" processes. 
  • Disaggregation can occur consistent with Government’s timeframe to achieve new structures from 1 July 1998. 
  • Consistent with the HEC timetable for change.
 
Separate GBEs Yes
  • Unlikely to affect sale price. 
  • Potentially less acceptable than private company due to more limited familiarity in marketplace. 
  • Not tested for lease.
 
  • New legislation required. 
  • Requires minimum six months’ trading results for "due diligence" processes.
 
Subsidiaries of existing HEC Yes
  • Not preferred for sale as the model increases the separation risk. 
  • Could only be considered as interim position to simplify initial separation. 
  • Not tested for lease.
 
  • No new legislation required. 
  • Would require additional time to move to full separation and have minimum of six months’ trading results.

  1. Introduction
1.1 Background
 
 

The Public Accounts Committee Act 1970, provides for the establishment of a joint committee, comprising three members from the Legislative Council and three from the House of Assembly, with the function of inquiring into, considering and reporting to the Parliament on any matter referred to it by either House.
 
 

The current membership of the Public Accounts Committee (PAC) is as follows:
 
 

Mr George Shaw MLC (Chair)

Mr Peter Schulze MLC

Dr David Crean MLC

Mr Robert Mainwaring MHA

Mr David Llewellyn MHA

Mr Michael Foley MHA
 
 

 The Committee has the power to summon witnesses to appear before it to give evidence and to produce documents (s7(1)) and, except where the Committee considers that there is good and sufficient reason to take it in private, all evidence is taken by the Committee in public (s7(3) as amended).
 
 

On Thursday 9 December 1998, the PAC received a reference from the Legislative Council through the following motion, which was agreed to following debate:
 
 

‘That the Legislative Council request the Standing Committee of Public Accounts to assess and report on the revenue implications for the Consolidated Fund on disaggregation of the Hydro Electric Corporation and other related matters.’
 
 

1.2 Issues Underpinning the Reference
 
 

In moving that the matter be referred to the Public Accounts Committee (PAC) the debate reflected discussion and concern arising from the Electricity Companies Bill 1997 which had previously been debated and passed by the Parliament.
 
 

The Electricity Companies Bill 1997 provided for the establishment of companies for one or more of the transmission, distribution, and retailing of electricity in Tasmania. It was the view of many members of both Houses of Parliament that there was a dearth of information regarding the motivations behind the Bill and its financial implications.
 
 
 
 

1.3 The Committee’s Terms of Reference
 
 

The PAC met on 22 December 1997, reviewed the reference and established a range of matters that were to be considered in the Terms of Reference. The Terms of Reference were then publicly notified in newspapers on 10 January 1998. The Terms of Reference stated:
 
 

The Standing Committee of Public Accounts has received a reference from the Legislative Council
 
 

‘to assess and report on the revenue implications for the Consolidated Fund on disaggregation of the Hydro-Electric Corporation and other related matters’.
 
 

The Committee has determined that ‘related matters’ include Basslink and the sale of equity in the Hydro Electric Corporation.
 
 

The following points may also be considered in relation to the Terms of Reference:-
 
 
  1. The direct and indirect social usefulness of this public asset.
  2. The impact on consumers and specific groups in the community and the quality of service to them.
  3. The retention value of the enterprise measured against its sale and disaggregation value.
  4. The impact on employment, skills training and conditions and the protection of the existing workforce.
  5. The existing competing demands on the Tasmanian Public sector and existing budgetary constraints and/or the alternative sources of funds for public sector investment.
  6. Current environmental impact and the need to continue and enhance environmental protection.
  7. Any administrative economies of scale and coordination that may be facilitated by (public ownership) sale or disaggregation.
  8. Appropriate weighting of long term as well as short to medium term considerations.
  9. Any other relevant matters.

 
 

On 9 March 1998, following developments on the options for the process of equity withdrawal from the HEC, the Committee resolved to explicitly recognise the option of a long-term lease in addition to a sale. The resolution recorded in the Minutes is:
 
 

That recognition of a lease option be included by adding "/lease" to the word sale wherever occurring in the description of related matters and points which may also be considered in relation to the Terms of Reference.
  1.4 Collection and Evaluation of Evidence
 
 

Following the establishment of its Terms of Reference, the Committee advertised publicly on 10 January 1998 seeking submissions from any interested parties. In addition, the Committee sought advice from various individuals including the Hon J Cleary, MHA, on appropriate witnesses to call to give evidence on the matters under consideration.
 
 

The Committee received 10 submissions and, as at 16 April 1998, has heard evidence from 44 witnesses (not including return presentations) in Hobart, Melbourne and Sydney.
 
 

The Committee has gained a significant volume of material through submissions, witness presentations, committee questioning, the subsequent tabling of reports, additional information on specific questions and independent research of issues. A list of witnesses interviewed and the reports and other information formally taken into evidence are provided as Appendices.
 
 

All witnesses were offered the chance to make a general presentation on the Terms of Reference, following which a question and answer model was adopted with Committee members exploring issues as seen necessary. In the case of certain key witnesses, several attendances were necessary to cover all the issues. Copies of all evidence have been provided to each member of the Committee.
 
 

In its work the Committee has been supported by the Executive Officer, Ms Heather Thurstans and two officers, Mr Simon Barnsley and Ms Sarah Male, seconded from other agencies to assist in analysis and report development. The Committee is grateful for their positive contribution.
 
 

The Committee has met on the following days in the pursuit of its inquiry:
 
 
 
Wednesday 10 December 1997 Wednesday 25 February (Melbourne) Monday 30 March
Monday 22 December 1997 Monday 9 March Monday 6 April
Friday 23 January  Tuesday 10 March Tuesday 7 April
Monday 2 February  Thursday 12 March Wednesday 8 April
Wednesday 11 February  Friday 13 March Thursday 9 April
Friday 13 February Wednesday 18 March (Sydney) Wednesday 15 April
Monday 23 February (Melbourne) Thursday 19 March (Sydney) Thursday 16 April
Tuesday 24 February (Melbourne) Thursday 26 March  Friday 17 April

 

Members have invested significant time outside meetings in the reading and consideration of the material presented. Transcripts of all witnesses’ sworn evidence (except that taken in camera) have been placed on the Internet and are accessible at http://www/parliament.tas.gov.au/pacc.htm
 
 

1.5 Interim Report on Disaggregation
 
 

Due to the need to address initially the matter of disaggregation of the HEC, consistent with the Electricity Companies Act 1997, this report does not consider all matters covered in the Terms of Reference. The PAC accepted the priority of Government to resolve the matter of disaggregation and has thus reported on this area to allow relevant decision making processes to continue. The Committee has concluded most of its evidence gathering on the issue of disaggregation and has chosen to produce this Interim Report.
 
 

In preparing the Interim Report the Committee has had regard to the evidence provided through a very intensive program of investigation and analysis. In many cases, submissions and witnesses addressed matters relating to all aspects of the Terms of Reference and were not confined to the issue of disaggregation of the HEC and its impact on the Consolidated Fund.
 
 

The Report is confined to the issues arising out of the Government’s proposals for disaggregation. Basslink and the sale or lease of HEC assets is touched on in this report but a comprehensive coverage of these two issues will be provided in subsequent reports.
 
 

The Interim Report is structured in five Chapters. Chapters 1 to 3 provide background and context to the Report by describing the process of electricity reform that is currently underway in Australia and the rationale behind this reform agenda, including national competition policy and microeconomic reform objectives and a description of the National Electricity Market. Chapters 4 and 5 discuss the matter of disaggregation of the Hydro-Electric Corporation and associated issues and provide the Committee’s findings and conclusions in this respect.
 
 
 
 

  1. Overview of Electricity Reform in Australia

    2.  

     
     
     
     

    During the 1990’s an agenda for reform of the Australian electricity sector has emerged to encourage and coordinate the most efficient, economic and environmentally sound development of the electricity industry in eastern and southern Australia through the development of a national grid. The reforms are designed to advance cooperation in the electricity industry, the absence of which has led to excessive generation capacity and inappropriate plant mix and fuel use.
     
     

    The agenda commenced with the 1991 Special Premiers’ Conference (SPC) decision to develop a National Electricity Market (NEM), following a 1991 Industry Commission report which highlighted the potential for significant gains from a competitive electricity market. The SPC decision has been progressively refined through a number of Council of Australian Governments (COAG) agreements from 1992 to 1994, and has been aligned with the development of a package of micro-economic reforms known as National Competition Policy Reform agreed to in April 1995. Under the 1995 Agreement States and Territories agreed to introduce a range of reforms in exchange for a set of financial payments from the Commonwealth.
     
     

    1. COAG’s Electricity Reform Agenda
The key objective of the COAG electricity reform agenda is to develop a fully competitive National Electricity Market (NEM) across participating jurisdictions. Participating jurisdictions currently include New South Wales, Victoria, the Australian Capital Territory and South Australia with Queensland intending to participate once the interconnection is built (expected about 2000 to 2001). Tasmania is not required to be a participating jurisdiction until such time as it is connected to the mainland grid, as is proposed through the establishment of Basslink.
 
 

The SPC established the National Grid Management Council (NGMC) in 1991 to develop an open market in electricity in the southern and eastern States of Australia. A set of rules and standards to govern trading and pricing arrangements under the NEM to be known as National Electricity Code of Conduct (NEC) has been developed. The NEC was submitted to the ACCC in November 1996 for accreditation and authorisation that was forthcoming in December 1997. Jurisdictions are now in the process of completing the steps required to give the NEC legal effect.
 
 

Participating jurisdictions have established two national companies - the National Electricity Market Management Company (NEMMCO) and the National Electricity Code Administrator (NECA) to oversee the operation of the NEM:
 
 

The trading and management/administration arrangements in the NEM are described in greater detail in Section 2.2, below.
 
 

The COAG agenda to introduce a range of benefits into the Electricity Supply Industry (ESI) aims to promote efficiency by increasing competitive pressures within and between State electricity grids. This is expected to deliver:
 
 

    1. The National Electricity Market
The National Electricity Market (NEM) has been designed to create competition in the generation and retailing of electricity across all of the participating jurisdictions.
 
 

In the past, the generation, transmission, distribution and retailing of electricity was all under the control of single publicly owned monopolies such as the Hydro-Electric Commission and the State Electricity Commission of Victoria (SECV). This model meant everything was planned and controlled centrally without the benefit of market signals to guide decisions. In some cases, this led to significant over-investment and created excess capacity in generation that presently exists in Victoria and New South Wales. There has been very limited electricity trading across state boundaries. South Australia has been purchasing electricity from Victoria and the Snowy Mountains scheme provided electricity to NSW, Vic and ACT.
 
 

In the competitive markets established in Victoria and NSW, and progressively in the NEM, generators must compete to supply electricity forcing them to operate as efficiently as they can. Retailers will be able to choose with whom they contract, which will put further pressure for efficiency in generation. The retailers themselves will also face competitive pressure on their price over cost margins and the need to better package services to meet their customers’ needs. It is argued by those involved in the development of the NEM that the benefits of competition that will accrue to consumers are lower prices and better choice and quality of services. The market price of electricity will determine whether new capital investment is needed and is economic.
 
 

The NEM works through a wholesale spot market or pool in which generators’ bids to supply power to the pool (and therefore to be allowed to generate) are matched against retailers’ (and potentially end-use customers) bids to buy power. This results in a price every half-hour, which varies depending on the electricity load required. The spot price for each half-hour (trading interval) is set at the average of six dispatch prices for each five-minute period in the trading interval. The highest price bid or offer dispatched in a five-minute period will set the dispatch price for that five minutes.
 
 

Retailers, generators, and customers large enough to buy wholesale, can all buy and sell through the pool. It means that the real value of electricity, in terms of what it is worth to customers and what it costs to produce, is determined as a market price. This allows the physical flow of electricity between generators and customers to be balanced by the system operator, NEMMCO.
 
 

With the price changing every half-hour, only those professionally skilled to deal in the wholesale market will choose to accept exposure to such a variable market price. To minimise this exposure it will be possible and prudent for most generators, retailers and larger customers in the market to enter into contracts to get a degree of certainty over price. A variety of contractual arrangements may be used for this purpose and will be brokered on behalf of market participants by traders.
 
 

While the prices between generators, retailers and large customers are determined under these competitive arrangements, because the transmission and distribution networks are natural monopolies, charges for access to, and use of, these networks are regulated so as to reflect fairly the cost. This price regulation is presently undertaken by each participating jurisdiction. As the market develops, the responsibility for price regulation of the interstate network will move to the ACCC.
 
 

As outlined above, the operation of the market is managed by NEMMCO that comprises members from each of the participating jurisdictions. The rules governing the NEM are contained in the National Electricity Code that is intended to ensure that competition is fair and ensures an efficient, secure and safe electricity system.
 
 

The ACCC is has commenced a process to develop transmission pricing arrangements for the national grid. In the Tasmanian context, Government Prices Oversight Commission (GPOC) is about to commence a pricing review for the Tasmanian transmission system.
 
 

The development of the NEM is seen as a principal component of Australia’s ongoing micro-economic reform agenda. The main objectives of the fully competitive NEM, as specified by COAG at a meeting on 19 August 1994 are:
 
 

The NEM will allow energy supply companies to trade across State and Territory boundaries through a single wholesale power ‘pool’ with the expectation that consumers will be able to reap the benefits of competition using their power of choice to obtain better deals on price and quality of service.
 



 



 

    1. National Competition Policy Reform
In 1991 Commonwealth, State and Territory governments agreed to examine a national approach to competition policy. An independent inquiry into national competition policy was commissioned in October 1992 and its report, now known as the Hilmer Report, was subsequently released in August 1993.
 
 

The recommendations of the Hilmer report were considered by Commonwealth, State and Territory governments and led to agreement on a competition policy reform package in April 1995. The substance of this reform package is to extend the scope of the Trades Practices Act 1974 and establish a process to identify and remove impediments to competition throughout the economy. It includes the establishment of the Australian Competition and Consumer Commission (ACCC), which assumes the functions of the Prices Surveillance Authority and acts as regulator for many industry access arrangements.
 
 

Three inter-governmental agreements were signed at the April 1995 meeting of COAG to support the reform package:
 
 

  1. the Competition Principles Agreement which is the key agreement aimed at removing impediments to competition including legislation, special advantages and disadvantages conferred on some GBEs, restriction on the entry of competitors, monopoly pricing and the structure of some monopolies.
  2. the Conduct Code Agreement which sets out the basis for extending the application of the Trades Practices Act, including to GBEs; and
  3. the Agreement to Implement the National Competition Policy and Related Reforms (or the ‘Money’ Agreement as it has been termed), which provides for redistribution of some of the tax gains, accruing to the Commonwealth as a result of reform, back to the States and Territories which have implemented the reforms.
Under the Competition Principles Agreement the National Competition Council (NCC) was established to assess the progress of each State/Territory with their competition policy and related reforms prior to recommending to the Commonwealth whether they should receive payments under the ‘Money’ Agreement or not. The Reform Requirements and anticipated Competition Payments to Tasmania are set out in the Table below. In addition to the Competition Payments there is an additional per capital Financial Assistance Grant (FAG) Guarantee also associated with the National Competition Policy Agreements. The amount of these FAG payments commences in 1997-98 with a payment of $7.6 million and rises to $62.7 million by 2005-06.
 
 
 
 
 
Tranche  NCP Electricity Reform Requirements Anticipated NCP Payments to Tasmania

(1996-97 prices)
First Tranche, commencing 1997-98
  • Relevant jurisdictions must have taken all measures necessary to implement an interim competitive NEM. 
  • While Tasmania remains not interconnected it is not regarded as a relevant jurisdiction. 
  • NCC assessed Tasmania as having achieved satisfactory progress in the context of being a non-relevant jurisdiction and Tasmania received its first Tranche payment in 1997-98.
 		 Competition Payment:

$5.5 million annually for 1997-98 and 1998-99

FAG Guarantee:

1997-98 $7.6 million

1998-99 $14.4 million

 
Second Tranche, commencing 1999-00
  • Relevant jurisdictions must have completed the transition to a fully competitive NEM by 1 July 1999.
  • Tasmania’s position will depend on development of interconnection to join the NEM.
 		 Competition Payment:

Rises to $11.0 million annually for 1999-00 and 2000-01

FAG Guarantee:

1999-00 $21.1 million

2000-01 $28.0 million

 
First Tranche, commencing 2001-02
  • Relevant jurisdictions must have continued their effective observance of the COAG electricity reform requirements.
  • Tasmania’s position will depend on development of interconnection to join the NEM.
 		 Competition Payment:

Rises to $16.4 million annually from 2001-02 onwards

FAG Guarantee:

2001-02 $34.9 million

2002-03 $41.9 million

2003-04 $48.8 million

2004-05 $55.7 million

2005-06 $62.7 million

 

 

The reforms required for NCP payments include the facilitation of a NEM by participating jurisdictions. The NCC has indicated that Tasmania is not considered a participating jurisdiction while it remains unconnected with the mainland grid but would be required to meet the NEM requirements if interconnected. Tasmania has received its first tranche payment but will need to comply with a number of obligations in relation to electricity reform in order to qualify for its second and third tranche payments. These obligations will exist but differ depending on whether Tasmania interconnects to the mainland grid or not.
 
 

The Tasmanian Government has committed to joining the NEM through the proposed development of Basslink subject to its economic viability. In the view of the NCC, this commitment has placed special obligations on Tasmania over time in contrast to other non-participating jurisdictions. This issue is developed at Section 2.5.1.
 
 

    1. State and Territory Progress in Reform
2.4.1 Market Development
  Victoria has led the development of a wholesale electricity market, one having commenced in July 1994, administered by the Victorian Power Exchange. This, together with the market established in New South Wales in May 1996, has provided the basis for an interim and transitional phase of the NEM known as NEM1, which commenced on 4 May 1997. The ACT is also a participant in NEM1, allowing it to import electricity from Victoria as well as its traditional source in NSW.
 
 

South Australia is connected to the Victorian transmission system and is presently undertaking the necessary structural changes prior to officially joining the NEM in 1998. Queensland is in the process of developing an interconnection with NSW to become part of the NEM in 2001.
 
 

The commencement NEMMCO’s operation of the NEM was due on 28 March 1998 but has now been delayed until mid-May 1998 to allow for full testing of the software and management systems that will integrate the market. The generation and interconnection capacities across the existing and proposed eastern states system are illustrated in the diagram below.
 
 



Source: Department of Treasury and Finance, Victoria, Victoria’s Electricity Supply Industry Towards 2000, June 1997, p.41.
 
 
  2.4.2 Structural Reform
 
 

Victoria
 
 

The former State Electricity Commission of Victoria (SECV) went through a series of changes commencing in October 1993.
 
 

Stage 1 - From monopoly to independent businesses (October 1993)

The disaggregation of the vertically integrated SECV to create three State-owned bodies (equivalent to GBEs) to operate the generation, transmission and distribution/retail components of the former SECV.
 
 

Stage 2 - A competitive industry is established (October 1994) The creation of eight State-owned companies (established under Corporations Law) operating in a competitive framework: Stage 3 - Implementation (From October 1994) Completion of structural changes and implementation of new commercial arrangements so that privatisation of the various businesses could be undertaken. This comprised: A process of privatisation then occurred in Victoria with all distribution companies privatised during 1995, four generation businesses privatised in the period May 1996 to April 1997 and the transmission business privatised in 1997.
 
 

The process has included development of accompanying regulatory structures including the Office of the Regulator General and the Office of the Electricity Ombudsman.
 
 
 
 

Other States
 
 

In other States, the changes have not been as radical as those in Victoria but all demonstrate significant changes as summarised in the Table below.
 
 
State/Territory Progress
New South Wales

 
  • Electricity Commission of NSW (Pacific Power) restructured in 1991 into commercially oriented business units, with the Network (transmission) business unit formally established as a separate legal entity in 1994.
  • Disaggregating Pacific Power into three state-owned corporations (GBE comparable) – Pacific Power, Macquarie Generation and Delta Electricity – from March 1996 created three principal generators.
  • Transmission is operated by a separate entity Transgrid that has responsibility for implementation of the NSW wholesale electricity market.
  • 25 distribution authorities amalgamated into six large state-owned corporations operational from March 1996.
  • Working to a timetable of fully deregulating its retail market by July 1999.
South Australia
  • In 1995 Electricity Trust of South Australia (ETSA) corporations (GBE comparable) was established as a holding company with four wholly owned subsidiary corporations ETSA Generation, ETSA Transmission, ETSA Power and ETSA Energy
  • ETSA disaggregated to form two entities in Jan 1997 -– ETSA Corp. and Optima Energy
  • ETSA Corp. retained ownership of the previous subsidiary companies of ETSA Transmission, ETSA Power (distribution and retail) and ETSA Energy (energy trading)
  • Optima Energy is the generation corporation
  • SA is a major importer of electricity from Victoria via connection to the Victorian transmission system 
Queensland
  • Queensland Electricity disaggregated into (a set of GBEs):
  • three state-owned generation businesses;
  • an engineering services business;
  • seven distribution businesses;
  • three state-owned retail businesses; and
  • an autonomous transmission entity known as Powerlink
  • Planning to interconnect with NSW and has created an interim competitive wholesale market with the intention to move towards a fully competitive market including retail deregulation by 2001.
Australian Capital Territory
  • Government owned retailer and distributor has been corporatised
  • Government has recently indicated intention to deregulate its retail market
  • Electricity supplied to the ACT is generated in NSW but participation in the NEM will also allow the ACT to source from Victorian generators.
Western Australia,

Northern Territory
  • Although signatories to NCP Agreements, WA and NT have not been party to the COAG national electricity agreements and are not therefore participating jurisdictions in the context of the NEM. 
  • WA has created a GBE, Western Power, which is ring-fenced into five entities although it continues to operate as a vertically integrated monopoly
  • WA developing its own State-based competitive market and is introducing a third party access system to both transmission and distribution
  • The NCC has indicated to Western Australia that "it is essential that electricity generation and transmission functions are structurally separate to ensure that the anticipated benefits from a more competitive electricity market are achieved. WA has advised the Council that it is currently considering this matter.

 
 
 
    1. Tasmania’s Progress in Reform
When considering reform in Tasmania in comparison to other States, the Committee considers that it is necessary to give recognition to the unique features of the Tasmania ESI. Whilst there are many common elements to the process and elements of reform in several Australian States, particularly those already forming a part of the NEM, it is not axiomatic that these features are in the best long term interest of Tasmania.
 
 

Several unique issues to consider for Tasmania are:

 2.5.1 Commitments under NCP and COAG Agreements
  Structural Review
 
  The NCP Competition Principles Agreement requires the Tasmanian Government to undertake a structural review of a public monopoly before it introduces competition to the market traditionally supplied by the public monopoly, or before it privatises the public monopoly or any part of it.
 
 

The NCP Structural Reform Principles, as contained in Treasury’s supporting information, state:
 
 

Box 1: National Competition Policy Structural Reform Principles
 
 

Clause 4 of the Competition Principles Agreement states that:
 
 
  1. Each party is free to determine its own agenda for the reform of public monopolies.

    2.  

     
     
     

  2. Before a party introduces competition to a sector traditionally supplied by a monopoly, it will remove from the public monopoly any responsibilities for industry regulation. The party will re-locate industry regulation functions so as to prevent the former monopolist enjoying a regulatory advantage over its (existing and potential) rivals.

    3.  

     
     
     

  3. Before a party introduces competition to a market traditionally supplied by a public monopoly, and before a party privatises a public monopoly, it will undertake a review into:
  1. the appropriate commercial objectives for the public monopoly;

    2.  

     
     
     

  2. the merits of separating any natural monopoly elements from potentially competitive elements of the public monopoly;

    3.  

     
     
     

  3. the merits of separating potentially competitive elements of the public monopoly;

    4.  

     
     
     

  4. the most effective means of separating the regulatory functions from the commercial functions of the public monopoly;

    5.  

     
     
     

  5. the most effective means of implementing the competitive neutrality principles set out in the CPA;

    6.  

     
     
     

  6. the merits of any community service obligations undertaken by the public monopoly and the best means of funding and delivering any mandated community service obligations;

    7.  

     
     
     

  7. the price and service regulations to be applied to the industry; and

    8.  

     
     
     

  8. the appropriate financial relationships between the owner of the public monopoly and the public monopoly, including the rate of return targets, dividends and capital structure.
  1. A party may seek assistance with the review from the (National Competition) Council. The Council may provide such assistance in accordance with the Council's work program.
A structural review of the HEC’s distribution and retail businesses has been conducted in accordance with Clause 4(3) of the Competition Principles Agreement because of the Government’s intention to privatise these businesses. This was documented in National Competition Policy, Review of the Structure of the Hydro-Electric Corporation’s Distribution and Retail Businesses, December 1997 (the Reeves-Breslin Report).

In the context of the Government’s proposal, the NCC has indicated that a structural review of the HEC’s transmission business is not required as it is a natural monopoly and is to be separated out into a stand-alone entity and regulated in a manner fully consistent with NEC. The NCC is of the view that such reviews already undertaken in other States are sufficient to meet this commitment.
 
 

A structural review of the HEC generation business is to be conducted prior to Tasmania joining the NEM. The State has confirmed with NCC its intention to pursue interconnection with the mainland grid via Basslink and therefore to enter the NEM at which time it will be considered a participating jurisdiction and as such be bound by the terms of the NCP Agreements.
 
 

It is important to note that the role of the NCC is to review proposals that are put before it, rather than to recommend a particular course of action, which is considered to be the role of the individual jurisdiction. Because of this, although it can be argued that the NCC has been satisfied with the Government’s proposal to date, it has not been presented with any alternative propositions so it can not be argued that the NCC has selected the Government’s position in preference to others.
 
 
 
 

 Structural Separation
 
  The NEM and COAG Agreements require structural separation of the generation, transmission and distribution elements of the electricity supply industry to ensure that the anticipated benefits from a more competitive electricity market are achieved. The NCC has indicated a strong view that ring-fencing these operations is insufficient.
 
 

As a condition of the State’s commitment to join the NEM, structural reform through the disaggregation of the HEC will be necessary with a minimum requirement that the transmission business be separated out by the time of entry.
 
 

The Tasmanian Government has participated in a series of Agreements at Special Premiers’ Conferences and COAG meetings that have successively committed the State to reform of its electricity sector. These are set out in the Table below:
 
 
 
 
 
 
Meeting Relevant Agreements
SPC, Brisbane 30-31 Oct 1990 Premiers agreed to set up a working group to assess benefits from an extension of, and/or organisational changes to, the electricity grid covering NSW, Vic, Qld, SA, Tas and the ACT

 
SPC, Sydney 30 Jul 1991 Premiers
  • agreed to establish the NGMC including representatives from NSW, Vic, Qld, SA, Tas and the ACT. 
  • requested more detailed technical appraisals of the proposed links to Tas and Qld for results to be made available at the Nov meeting.
 
Premiers’ and Chief Ministers Meeting, Adelaide 21-22 Nov 1991 SECV and HEC reported that there are significant potential gains from a link between the two States.

 
Heads of Government, Canberra 11 May 1992 Heads of Government:
  • agreed to develop an interstate transmission network across eastern States, and, to achieve agreed to the principles of separate generation and transmission elements in the electricity sector 
  • Tasmania’s participation in the national grid was noted to be dependent on the development of the Basslink proposal. 
 
COAG , Perth 7 Dec 1992 Heads of Government:
  • noted work on the development of an interstate transmission network 
  • reaffirmed their commitment to the principle of separate generation and transmission elements 
 

 
 
 
COAG, Melbourne 8-9 Jun 1993 Relevant Heads of Government:
  • announced a firm commitment to have the necessary structural changes in place to allow a competitive electricity market to commence from 1 July 1995 
  • confirmed their commitment to the establishment of an interstate transmission network, separate from generation and distribution interests 
  • Tasmania reserved its position pending the outcome of its current review of the structure of its electricity supply industry
 
COAG, Hobart 25 Feb 1994 Relevant Heads of Government agreed to the principles for a NEM of a uniform approach to network pricing and regulation, and a form of vesting contracts for managing the transition to a competitive market

 
COAG , Darwin 19 Aug 1994 Relevant Heads of Government noted substantial progress in structural reform to achieve a competitive market and that review of the ESI in both Tas and SA are underway with a view to structural reform consistent with the national model

 
COAG, Canberra April 11 1995 All Australian Governments reached agreement on NCP and signed the three inter-governmental agreements underpinning it (see Section 2.3, above)
 
 

Related reforms to the electricity industry established in previous SPC and COAG meetings formed part of the NCP package.

 
Leaders’ Forum Adelaide 12 Apr 1996 Leaders discussed the creation of a NEM and reaffirmed their commitment to implementing the COAG agreements

 

 

2.5.2 Legislative Reform
 
 

A package of legislation, principally the Electricity Supply Industry Act 1995 has been passed through the Tasmanian Parliament creating a framework for increased competition in the Tasmanian ESI. This Act removed the HEC’s statutory monopoly on electricity generation and transferred its regulatory and advisory responsibilities to Government Agencies, primarily the Office of Energy Planning and Conservation (OEPC).
 
 

At the same time the Government introduced the Government Prices Oversight Act 1995 to establish the GPOC to independently assess the costing and pricing policies of public monopolies (including the HEC) to ensure that monopoly power is not being abused.
 
 

GPOC makes recommendations to the relevant Ministers on the pricing of government monopoly services. Under the Act, the Minister for Energy is required to set maximum prices for electricity tariffs to retail customers for a three-year period, taking into account the recommendations from GPOC. In the context of the structure of the NEM discussed in Section 2.2, above, GPOC holds the jurisdiction responsibility in Tasmania for the regulation of transmission and distribution pricing.
 
 

2.5.3 Disaggregation of the HEC
 
 

In accordance with the requirements of the Competition Principles Agreement, the Minister for Finance commissioned a structural review of the HEC’s distribution and retail businesses, the Reeves-Breslin Report, which was completed in December 1997. This report recommended that "the distribution and retail businesses of the HEC should be carried out by separate legal entities in a competitive Tasmanian electricity market" and that "full separation be implemented prior to the introduction of competition in the Tasmania electricity market."(pxiii) This recommendation was based on the view that "… a single distributor/retailer with ring fenced functions would clearly not provide the same level of open access and retail competition and substantially lessens the chances that competitive gains in the generation sector would be passed through to consumers."
 
 
 
 

The Government rejected the Reeves/Breslin recommendation to split distribution and retail and has indicated its intention to disaggregate the HEC into generation (including system control), transmission and combined distribution/retail businesses. The Government’s decision to reject the Reeves/Breslin recommendation was based on the following views:
 
 

 The Government subsequently introduced the Electricity Companies Bill 1997 into Parliament to provide for the establishment of one or more companies (limited by shares and incorporated under the Corporations Law) for the transmission, distribution and retailing of electricity in Tasmania.
 
  … with each such company having as its primary purposes one or more of the following activities:
    1. the transmission of electricity;
    2. the distribution of electricity;
    3. the retailing of electricity;
    4. any other activity, other than the generation of electricity, related to or associated with the transmission, distribution or retailing of electricity.[s5(1)]
If the Government proposes to form such a company, Section 5(2) of the Act requires the Minister for Energy to lay before both Houses of Parliament a statement specifying –
 
    1. the intention to so form or participate in the formation of such a company; and
    2. the primary purposes of the company; and
    3. any other information the Minister considers appropriate.
Both Houses of Parliament must approve the Minister’s proposal before a company can be formed.
 
 

The Electricity Companies Act 1997 was passed by both Houses of Parliament and received Royal Assent on 22 December 1997.
 
 

2.5.4 The Government’s Plans for Further Reform
 
 

The Government has also outlined proposals to part privatise the HEC through the sale or lease of the transmission and distribution/retail businesses and to participate in the NEM through an undersea interconnector called Basslink between Tasmania and the mainland grid in Victoria.
 
 

There is a range of factors driving further reform in Tasmania from national competition policy and industry reform, including the intention for Tasmania to participate in the emerging NEM, to local drivers such as the new vision for the HEC developed by its Board. The rationale for reform in the context of disaggregation is discussed further in Chapter 5, below.
 
 
 
 
 
 
  1. The Rationale for Electricity Reform in Tasmania

    2.  

     
     
     
     

    When considering how best to approach its complex terms of reference, the PAC developed an agreed framework that analyses the rationale behind the Government’s proposed electricity reform agenda. This links the problems and issues the Government is trying to address, the means by which it is trying to address them, and the ultimate outcomes that it is seeking to achieve. This framework is illustrated and described in this Chapter.
     
     

    1. The Problems and Reform Issues
There are broadly four sets of problems or reform issues facing the State that the proposed reforms to the State’s electricity supply industry are designed to address. These are discussed in Sections 3.1.1 to 3.1.4, below. 3.1.1 Obligations under the NCP and COAG Agreements
 
 

The State has obligations through NCP commitments and the COAG reform agenda to introduce regulation and competition into its electricity market as discussed in Chapter 2, above.
 
 

 In summary these include:
 
  Other States are moving to reform in readiness for their participation in the NEM and in order to meet their commitments under these Agreements. Tasmania’s obligations under NCP are very clear if Basslink proceeds. If Basslink does not proceed these obligations, and therefore the imperatives for associated reform, are less clear. This issue is discussed in more detail in Section 5.1, below.
 
 

3.1.2 Business Imperatives for the Hydro-Electric Corporation
 
 

Evidence provided to the Committee by many witnesses indicated that there has been a compelling need to improve the efficiency of electricity supply authorities around Australia. Some held the view that there would be significant productivity and efficiency gains to be made through the disaggregation and a consequent improved business focus of the HEC.
 
 

The best argument we have in those sorts of terms at the moment is the business focus argument that, if in fact you disaggregate the units into areas of activity that have got fairly clear focus to them, rather than having to be concerned about all the integration elements, that is one of the ways of removing under-performance in those terms.
  Several witnesses acknowledged that there is a cycle to organisational change with "disaggregation and aggregation occurring from time to time, and probably at any one time some industries or some businesses are going one way and some are going the other way" it was also argued that it is change itself that is required to yield efficiency gains rather than the nature of the change.
 
 

Evidence from the HEC highlighted that, as a consequence of the changing electricity industry, nationally and internationally, and the need to improve the organisation’s business focus, change is inevitable for the HEC.
 
 

Central to the Board’s strategy for positioning the business in the changing electricity environment is the indisputable fact that the status quo is not an option for the HEC.
 
 

The end of the hydro-industrialisation era in the early 1990s and the introduction of reforms to the electricity market Australia wide in 1995 heralded a period of immense change for the HEC and its business.
 
 

Following a series of strategic planning workshops in 1996 and early in 1997, the HEC Board advised the Tasmanian government that a failure to embrace change would not just result in stagnation for the HEC as a business but in its serious decline and loss in its total value. In this environment, to stand still, or to refuse to change, is to go backwards.
 
 

 The HEC further argued that there are potential efficiency gains from disaggregation that come from breaking up the "culture of one business" and by "concentrating the efforts of management … to make sure the decisions that they are making are decisions which fit that business" suggesting that a "one-size-fits-all-approach" is not appropriate when different parts of the entity have different risk profiles.
 
 

3.1.3 The State’s Economic and Fiscal Position
 
 

The public sector finance problems facing Tasmania are considered to require greater access to revenue for the Consolidated Fund. In economic terms, Tasmania has relatively high unemployment and low growth. There is also a significant debate on the level of state debt and the State’s capacity to service this debt. These issues will be considered in detail in subsequent reports.

3.1.4 Future energy supply and risk management
 
 

Current energy demand forecasts, if correct, indicate that within three years, the total electricity load required will exceed the hydro system capability and that after nine years (the year 2005-06) this gap would grow to 100MWaverage (approximately 9% of system capability). While this could be met in the short term through a combination of demand-side management and running down the water storages, it is not a sustainable long term position, particularly in the event of lower than average rainfall or drought.
 
 

The Committee has not concluded its investigations of future energy requirements. This issue will be considered in detail in subsequent reports.
 
 
 
 
    1. The Proposed Solutions
3.2.1 The Government’s Position
 
 

In April 1997 the Premier, the Hon Tony Rundle MHA, launched the State Government’s Directions Statement which contained a package of initiatives. These include:
 
  3.2.2 The Outcomes Sought
 
 

In pursuing its strategies for economic and fiscal recovery and integrated energy development the Government put forward evidence to the Committee that it is seeking to achieve a range of outcomes. These are listed on the right-hand side of the diagram.
 
 

3.2.3 Alternative Solutions Proposed
 
 

During the course of its inquiry, the Committee has identified alternative views to those of the Government about the solutions to the problems that Tasmania faces. These views will be discussed in subsequent reports.
 
 

In the context of this interim report, there is an alternative view that structural separation of the HEC can occur by ring-fenced business units, subsidiary companies or GBEs as opposed to the fully separated companies proposed by Government. Underpinning this view is the belief that it would be more appropriate to work towards an alternative time frame which addresses the need to reform the ESI in the absence of equity withdrawal and/or Basslink.
 
 

The following diagram illustrates the discussion above including both the options proposed by Government and a range of alternative views.
 
 
    1. The Relationship Between Disaggregation, Sale/Lease and New Supply Options
The rationale for the disaggregation of the HEC’s generation, transmission and distribution/retail businesses on its own (ie without considerations of the sale/lease, new energy supply options including entry to the NEM via Basslink) arises from:
 
  When the issue of the sale or lease is brought into the picture then a further argument for disaggregation emerges in that the entities to be sold or leased must be structurally separated beforehand.
 
 

When the development of new energy options such as Basslink are also brought into the picture then it is argued that disaggregation is necessary because it allows for both the development of competition in generation and the State’s obligations under the COAG reform agenda to be fully met.
 
 

A full analysis of the reasons to disaggregate is provided in Chapters 4 and 5 below.

  1. Structural Approaches to Disaggregation

    2.  

     

    1. The Current Structure of the HEC and its Operation as a Vertically Integrated Monopoly

      2.  

       
       
       
       

      The HEC is a state owned corporation structured under the Government Businesses Enterprise Act 1995. It is a vertically integrated monopoly in the electricity supply industry in Tasmania. A single Government appointed Board manages the HEC.
       
       

      Vertical integration has in the past been the norm in the operation of electricity supply authorities in Australia. Vertical integration offers the benefit of allowing a business to maximise its economies of scale in production and overheads, thus reducing its overall costs. Indeed, in August 1993 a report submitted by Cresap Langton to a joint HEC/Tasmanian Government team examining selected aspects of a future ESI in Tasmania, proposed that:
       
       

      … the most effective longer-term structure for HEC within the Tasmanian ESI is the first option, namely a vertically integrated company. This has been selected for the following reasons:

      It provides the most easily regulated pricing environment. …

      It clearly allocates the obligation to supply. …

      It produces more sustainable competition. …

      It is the lowest cost option. …

      It is the option that best supports HEC’s improvement of efficiency. …

      It is the option that provides the best non-price benefits to Tasmania. ….
       
       

      The opposing view is, however, that vertical integration can allow significant distortion of a business’s cost structure, exploitation of its market power and reduced efficiency. It allows for the operation of cross subsidies that distort both costing and pricing of services. It is also argued that, if competition is absent, there is no external pressure (in the absence of regulation) to adopt efficient cost structures and market based pricing, as the goal of the organisation will be overall profit maximisation.
       
       

      The Industry Commission in their review of ETSA made a comprehensive study of this matter. They drew attention to a 1991 study of 74 privately owned electricity utilities in the USA that "demonstrated costs would rise by almost 12 per cent if vertically integrated firms were to be separated into generation and network enterprises". That study also noted that competition at the generation stage may also lead to gains that offset efficiency gains from vertical divestiture. In summary, the Commission accepted that "vertical separation in the ESI will mean some trade-off exists between integration economies and the benefits of competition".
       
       

      Tasmania currently only has one Generation, one Transmission, one Distribution and one Retail business. Because the Transmission and Distribution businesses are natural monopolies and, in the current HEC integrated structure, generation and retail are not contestable, the development of competition in the ESI as the means of breaking monopoly power is difficult. The alternative to the introduction of competition is the introduction of a network access regime and the regulation of prices. Regulation of prices has been recently introduced in Tasmania through the Government Prices Oversight Act 1995 (see Section 2.5.2, above).
       
       

      Evidence from the Government, based on advice received from Ernst and Young in March 1998, claimed that benefits through the elimination of cross-subsidies and