NATIONAL AFFAIRS: by Patrick J. ByrneNews Weekly
Will Snowy Hydro sale create Australia's Enron?
, June 10, 2006
Shortly after this issue of News Weekly was printed the sale of Snowy Hydro was cancelled by the Federal, NSW and Victorian governments.The privatisation of Snowy Hydro could create another Enron-style California electricity crisis and further undermine the reliability of timed irrigation water releases down the Murray and Murrumbidgee River system. Both concerns are a threat to Australia's national interests, writes Patrick J. Byrne. At stake - in the current proposed sell-off of Australia's great infrastructure project, the Snowy Mountains hydro-electric scheme - is strategic control of both the principal water system and the principal electricity market in Australia. Control of these two markets is what is being sold.
The predictable disaster of privatisation will eventually cost state and federal governments many billions of dollars to rectify.
Snowy Hydro's owners are the NSW Government (58 per cent), the Victoria Government (29 per cent) and the Federal Government (13 per cent).Electricity monopoly
Snowy Hydro controls about 80 per cent of the peak-power generating capacity in the NSW and Victorian network. Its hydro- and gas-fired power stations can use their instantaneous power-generating capacity to meet electricity needs at peak times when the sale price can spike from an average $40 per megawatt hour to $10,000 per megawatt hour. Further, by storing some of the "free" water it accumulates, Snowy Hydro is storing hydro energy, which it sells as insurance to other electricity-generating companies against the potential of high peak-power costs.
In Australia, demand for electricity is outstripping supply, as there has been insufficient investment in ageing, privatised, base-load power stations down the east coast network. Many base-load power stations are approaching the end of their 40-year life, making them more prone to failures. These factors are likely to increase the demand for peak-load power.
Hence, Snowy Hydro occupies a unique, almost monopolistic, position in the national energy market, a position that cannot easily be emulated by other power-generating companies. With 80 per cent of the peak generating capacity for NSW and Victoria, it has a virtual monopoly on peak-power generation and so the potential to control the electricity market to its advantage.
The California electricity crisis of 2000-01 demonstrated that a company only needs 6-8 per cent of generating capacity to manipulate the market.
A corporatised Snowy Hydro Ltd is already in a position to use its market power to manipulate electricity prices at peak power times, except that its government owners would face a public outcry and pressure to restrain it from any obvious over abuse of its market power.
A privatised Snowy Hydro would be free of such restraints. If an existing power-generating company eventually obtained enough shares to gain a controlling interest in Snowy Hydro Ltd, their combined power capacity would further enhance their ability to manipulate market prices.
What is more, a corporatised or privatised company can argue that using its market power to produce higher prices is a legitimate part of its obligation to maximise profits for shareholders. Some in the industry are concerned that the corporatised Snowy Hydro may already have been exploiting its market power.
In its original form as a public utility, Snowy Hydro helped to stabilise the electricity market. It switched on the power at peak demand to help stabilise prices and minimise the ability of privatised companies to manipulate the electricity market. It was a safeguard against market manipulation.
Once it was corporatised and made subject to the company law, Snowy Hydro's power-generating focus shifted from stabilising the market to maximising profits for its shareholders - the Federal, NSW and Victorian Governments. Privatised, it will be maximising its profits for other shareholders.
Hence the irony: as California is building government-owned power generators to stop future manipulation of deregulated power markets, the NSW, Federal and Victorian Governments are about to sell Snowy Hydro, which traditionally safeguarded against manipulation of the electricity market.California and Enron
California partly deregulated its electricity market in 1998.
In 2000, a number of factors led to peak demands putting such a burden on electricity supply capacity that, starting in June, electricity prices soared to US$143 per megawatt hour, more than twice as high as in the same period the previous year. Over the next few months, electricity prices soared much higher. As Severin Borenstein, director of the University of California Energy Institute, has pointed out:
"These high prices produced enormous profits for generating companies and financial crises for the regulated utilities that were required to buy power in the wholesale markets and sell at much lower regulated prices in the retail markets. The state's largest utility, Pacific Gas & Electric, declared bankruptcy in March 2001. The state of California took over wholesale electricity purchases and spent more than $1 billion per month buying power in the spring of 2001, with average prices more than 10 times higher than they had been a year earlier.
"Accusations of price-gouging and collusion among the sellers were widespread. Some observers blamed the problems on the format of the wholesale auctions in California, while others focused on the way that transmission capacity is priced and how prices varied by location. A number of economists, myself included, did studies that concluded that sellers exercised significant market power."
The huge electricity price increases, blackouts and bankruptcy of Pacific Gas & Electric led then California Governor Gray Davis to declare a state of emergency, which lasted to 2003.
Eventually, to solve the problem, the California Public Utilities Commission "responded by cancelling retail competition" - in essence, returning to pre-deregulation days - "albeit with customers many billions of dollars poorer". Further, the California Public Power Authority is now building "state-owned" peak-load power plants to achieve 15 per cent reserve capacity to ensure there won't be another shortage and to ensure a competitive wholesale market.
This accords with the US Federal Energy Regulatory Commission, which has the power to monitor and mitigate market power. Until the California power crisis, it believed that "firms with a market share below 20 per cent could not exercise significant market power". Investigations found that in California's unregulated market, accused power-generation companies with "between 6 and 8 per cent of the production capacity in the independent system operator control area" used their market power to manipulate the electricity market, i.e., to engage in price-gouging and collusion.
Borenstein concluded: "A number of [US] state and federal policymakers have argued that the state should always make sure that capacity exceeds expected demand by at least 15 percent." (Journal of Economic Perspectives
, Winter 2000).
Of serious to concern to Australia's national interest is that a privatised Snowy Hydro Ltd, controls around 80 per cent of the eastern states' peak generating capacity from both its hydro-generators and other gas-fired peak-load power-stations it has acquired.
The Federal Energy Regulatory Commission (ERC) report on the California crisis reported that market manipulation was only possible as a result of the complex market design produced by the process of partial deregulation. Manipulation strategies were known to energy traders under names such as "Fat Boy", "Death Star", "Forney Perpetual Loop", "Ricochet", "Ping Pong", "Black Widow", "Big Foot", "Red Congo", "Cong Catcher" and "Get Shorty". Some of these have been extensively investigated and described in reports.
One of the energy wholesalers that became notorious for "gaming the market" and reaping huge speculative profits was Enron Corporation. Enron CEO Ken Lay mocked the efforts by the California State Government to thwart the practices of the energy wholesalers, saying, "In the final analysis, it doesn't matter what you crazy people in California do, because I got smart guys who can always figure out how to make money." (Evidence before the US Senate subcommittee on consumer affairs, foreign commerce and tourism, April and May 2002).
S. David Freeman, chairman of the California Power Authority at the time of the crisis, made the following statements about Enron's involvement in testimony submitted before the US Senate subcommittee on consumer affairs, foreign commerce and tourism on May 15, 2002:
"There is one fundamental lesson we must learn from this experience: electricity is really different from everything else. It cannot be stored, it cannot be seen, and we cannot do without it, which makes opportunities to take advantage of a deregulated market endless. It is a public good that must be protected from private abuse.
"If Murphy's Law were written for a market approach to electricity, then the law would state 'any system that can be gamed [manipulated], will be gamed, and at the worst possible time.' And a market approach for electricity is inherently gameable. Never again can we allow private interests to create artificial or even real shortages and to be in control."
Ken Lay's boast and S. David Freeman's hard-nosed analysis is a warning to Australian governments. No matter what regulations are put in place, in markets where the state owns less than 6–8 per cent of the generating capacity, then power corporations can find ways to manipulate the electricity market.
Ken Lay's Enron eventually went bankrupt. It was the largest corporate bust in history. He was recently convicted on fraud and conspiracy charges unrelated to the California electricity crisis.Irrigators short-changed
Under the terms of corporatisation, and now privatisation, of Snowy Hydro, there is little chance that irrigators in Australia's richest food-bowl will be able to have enforced the timing of water releases to suit their irrigation needs.
Snowy Hydro captures about 2,700 gigalitres annually. The Menzies Government constructed Snowy Hydro to provide 2,088 gigalitres of irrigation water annually down the Murrumbidgee and Murray River systems, and to provide a reliable alternative electricity supply in the wake of the communist-led coal-mining strike that was disrupting the electricity industry in the late 1940s. Its secondary purpose has been to generate electricity.
When Snowy Hydro was corporatised, it underwent a fundamental change in direction. The "Snowy Water Licence" of May 30, 2002, has been written with a clear intention of making electricity generation the primary purpose of Snowy Hydro Ltd, at the expense of efficient management of downstream irrigation. This has been done to enable Snowy Hydro to take advantage of its dominant position in the peak electricity market. The existing corporation, and hence the new privatised company, will have a 72-year lease on the management and use of Snowy Hydro's stored water.
Already, as a corporate government authority, Snowy Hydro earns $430 million annually by adding up to 200-300 gigalitres of water annually into storages which hold a total of about 5,000 gigalitres. This allows it to sell electricity insurance to base-load power-generating companies and hydro power - mostly at peak periods - into the NSW and Victorian electricity grids. Holding this water in storage enables Snowy Hydro to insure other electricity-generating companies against the potential $10,000 megawatt hour unit costs.
However, it may at times be more profitable for a privatised Snowy Hydro to hold water in storage to cover its insurance contracts with other electricity producers rather than release water - regardless of any downstream water needs for irrigation, environmental concerns or seasons of drought - as is indeed the situation at present.
Snowy Hydro is required to produce an Annual Water Operating Plan, with timing of irrigation water flows. The Snowy Water Licence 2002 gives the impression that farmers will have a decisive say over the timing of irrigation releases.
This is not the case. Even with an elaborate disputes-and-adjustment mechanism, Snowy Hydro is not obliged to implement a timed water release plan to suit downstream farm irrigators. Further, Snowy Hydro can vary the timing of water releases without penalty, so long as it can show "best endeavours" to comply with the Annual Water Operating Plan.
A legal opinion was sought as to whether farmers' water entitlements, including showing "best endeavours" to comply with the timing of deliveries, could be enforced under the Snowy Water Licence 2002. The barrister's opinion was that the terms of the Snowy Water Licence were probably unenforceable. The opinion concluded:
"In our view, because of:
• the limited extent to which parties other than the Licensee are able to influence the content of Annual Plans;
• the variability of the standard of obligations of the Licensee according to changes in circumstances; and
• the difficulties involved in mounting prosecutions for offences by the Licensee under the Act;
there is very limited scope for requiring, and enforcing, water releases of any particular amount at any particular time." (ACT lawyer C. E. Macphillamy's legal opinion provided to Mr Ian Morse, April 20, 2006).
Yet there seems to be a false perception - shared by many members of parliament, irrigators and others - that the Snowy Water Licence affords significant security of water to irrigators.
In contrast, when the Snowy Hydro was a government-owned utility, the government could step in to honour farmers' water licences and ensure timing of irrigation releases. In other words, governments can do what a privatised Snowy Hydro is unlikely to do: guarantee the security of farmers water entitlements.
Further, at some stage over the next 72 years, governments may alter water-use priorities. A government-owned body could do this at no net cost, as compensation would be payable by governments to the shareholders, who are the governments.Summary
Snowy Hydro Ltd has been transformed from its original purpose of being a government-owned utility, providing irrigation water and stabilising the electricity market in times of peak power using its huge hydro generating capacity.
Corporatisation has given it the power to control the wholesale price into the NSW and Victorian electricity markets during high demand periods. Privatisation delivers this power to a private company. This threatens future electricity crises in the eastern states, potentially on a scale comparable to that suffered by California in 2000-01.
Arguably, as a privatised company, Snowy Hydro would be obliged to use its market power to force up electricity prices in order to provide maximum returns to its shareholders.
Under the terms of the Snowy Water License 2002, "there is very limited scope for requiring, and enforcing, water releases of any particular amount at any particular time" in order to provide adequate and timed water releases to farmers down the Murray and Murrumbidgee River systems.
If the Federal Government and/or the states are eventually forced to buy back Snowy Hydro, or control of the water or part thereof, or to build new power-generating plants to stop market manipulation of the electricity market, as California is being force to do, the cost will be billions more than they will receive from the planned sale.
Therefore, the privatisation of Snowy Hydro must be halted. If the NSW and Victorian Governments insist on proceeding with the sale, the Federal Government must act in the national interest and use the Future Fund to purchase Snowy Hydro. - Patrick J. Byrne.