Pros and cons in Newman privatisation surge

The Queensland Budget was released yesterday afternoon, the centre-piece of which is the plan to raise $33.6 billion through the sale, privatisation, and leasing of public assets in a bid to pay-down debt and invest in further infrastructure.

Included in the privatisation program are: the SunWater industrial pipelines; electricity generators CS Energy and Stanwell; 99 year leases over the Gladstone Port Corporation, Townsville Port, and the Mt Isa rail freight line; and equity injections (not ownership) from the private sector into the electricity network.

As reported in The AFR:

Treasurer Tim Nicholls hopes to use the $33 billion raised to both pay down debt and regain the state’s AAA rating, which it lost in 2009, as well as leverage off the federal government’s infrastructure incentive program to pay for $8.6 billion worth of much-needed infrastructure.

Around $25 billion of the proceeds would be used to retire debt, taking the state’s balance to around $55 billion from $80 billion currently, and bringing it back in line with the minimum reduction recommended by the audit led by former federal treasurer, Peter Costello.

Treasurer Tim Nicholls also stated that the privatisation process could take up to six years, and that there would be “no fire sale of assets’’.

Included in the infrastructure program is a $5 billion bus and train tunnel beneath the Brisbane River, which will be contingent on the asset sales, as well as a range of road projects and the purchase of 75 new trains.

As argued previously, the notion that Queensland can “save” the budget and pay down debt via asset privatisation is misguided.

While the Government will receive funds up-front from such sales, it will lose the ongoing cash flow (dividend stream) from the assets – in effect substituting a future income stream for a lump-sum. Whether such privatisations are, therefore, beneficial to taxpayers depends on whether the upfront funds received by the Government outweigh the expected net present value of future dividends. If not, then the sale is likely to be detrimental to long-term budget finances.

Indeed, as reported in The Australian today, the assets on the auction block pump around $2 billion a year into the treasury’s coffers, implying a ‘yield’ of 6% that would be foregone via the privatisation process.

Financial issues aside, it is also unclear whether the proposed privatisations would be beneficial from an efficiency or equity perspective.

For example, many would argue against privatising essential utilities, like SunWater and the electricity generators, since these type of assets are natural monopolies facing minimal competition from other players, and there is the risk that a private player could attempt to gouge consumers by raising prices. The government would also be more likely to guarantee access to poorer members of the community, thereby improving social outcomes, as well as better enforce minimum quality standards, which are particularly important in the area of water supply (SunWater’s core business).

While some of these concerns could be overcome through regulation, such regulation would also likely lower the sale price on the assets, reducing proceeds to the government.

Having said that, productivity performance of Australia’s utility sector has been dreadful over the past decade and some components, such as the electricity distributors have been the worst offenders owing to over-investment and gold-plating. From the Second Garnaut Review:

There is a pressing need to revisit the state-owned distributors. There is an unfortunate confluence of incentives that may be leading to significant over-investment in network infrastructure. It is clear from market behaviour that the rate of return that is allowed on network investments exceeds the cost of supplying capital to this low-risk investment. The problems are larger where the networks continue to be owned by state governments. State government owners have an incentive to over-invest because of their low cost of borrowing and tax allowance arrangements. In addition, political concerns about reliability of the network, and about the ramifications of any failures, reinforce these incentives.

A comparison of costs between Victoria, where the network providers are in private hands, and New South Wales and Queensland, where the network providers are in state hands, provides compelling evidence to support this contention. While there are likely to be genuine differences between the states that explain some of these divergences, it is unlikely that these differences explain the majority of them.

Distribution networks are, of course, natural monopolies. So a strong regulatory regime is required to prevent price gouging.

The issue is obviously complex, but the Queensland should avoid looking for a short-term budget fix and proceed carefully on any privatisation of its essential utilities on a case by case basis.

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