Privatisation claims: Do they add up?

The privatisation of Victorian electricity assets in the 1990s has been lauded around the world as an example of strong microeconomic reform which delivered long term value for taxpayers.  Despite this the Andrews Labor Government made a partial re-entry of government into electricity generation, and potentially retailing a major part of its re-election pitch. In promoting this policy, the government frequently cited a claimed $23 billion in profits earned by Victorian generators since privatisation.

Although not revealed at the time, it is understood that this value did not come from government analysis, but rather was drawn from one part of an independent commentator’s views presented in The Conversation. The author of that article sought to support an opinion about profitability with some high-level estimates of generators’ Earnings Before Interest, Depreciation and Amortisation (EBIDTA).

The assumptions used to produce the $23 billion profit figure are difficult to to replicate and the AEC has not attempted this. However recent representations of this figure as lost returns to taxpayers from government-owned assets, as we saw in the recent Victorian election, are difficult to agree with and have subsequently been questioned. The use of this figure to suggest it represents some kind of extraction of excessive value from the Victorian public is also misleading. Indeed, when looked at against a counter-factual of retaining ownership, it is quite obvious that energy privatisation, especially of generators, has placed the Victorian public at a financial advantage to what would have occurred otherwise.

We take a look below.

Background to privatisation

In 1992 the Victorian economy was a in a perilous state, with debt accounting for approximately 30 per cent of gross state product (GSP). To address these issues the newly elected government embarked on a large-scale privatisation of electricity and gas assets, which ultimately resulted in the restoration of the state’s AAA credit rating. One of the generation assets was the 2000MW Loy Yang A coal-fired power station which was sold for $4.746 billion in April 1997 and is now slated to close in 2035, implying 38 years of operation in private hands.

Developments following privatisation

By 2002, the value of Loy Yang had dropped by 25 per cent and it was subsequently sold for $3.48 billion in April 2004. At that time, the original sale value was certainly shown to be a great deal for Victorians.

The proceeds of the asset sales were primarily used to pay down the state’s debt. According the 1998/99 Victorian State Budget, interest payments were $1.4 billion and outstanding debt was $14.3 billion. Based on this evidence a conservative average estimate of an interest rate of 5.02 per cent over the period since the sale can be assumed. This rate is based on the average of monthly 10-year NSW bond yields from April 1992.

If Loy Yang A had not been sold, and assuming the $4.746 billion of debt was paid down over the life of the asset with a 5.02 per cent average interest rate, the principal and interest payments for Victorians would have totalled $9.5 billion to the end of its life in 2035. Of this, interest payments account for $4.7 billion.

The article estimates the EBITDA of Loy Yang A has totalled $10 billion to date. EBITDA is generally a proxy for cash flow when conducting a discounted cash flow analysis for the purposes of valuation, however, in isolation it does not measure the cash available to equity and debt investors (ie, unlevered free cashflow). In simple terms the relevant stream of cash flows requires taxes paid, capital investment and net changes in working capital over the life of the asset to be deducted from EBITDA. These cash flows are then discounted to arrive at a net present value for investors. Analysis at this level of detail is beyond the scope of this EnergyInsider.

Loy Yang A is a capital-intensive business, which means that since it was sold there has likely been significant capital expenditure on the asset thereby reducing the cash flows available to investors. This, combined with the proceeds from the privatisation and the impact they had on the state’s debt illustrates the inappropriateness of the government’s use of the EBITDA estimate in isolation. And finally, the rehabilitation liabilities of the Loy Yang A site when it is decommissioned rest with the private sector.

Benefits of privatisation

The impact of 1990s privatisations is shown in Figure 1 and the corresponding impact on interest payments in Figure 2.

Figure 1

Source: https://www.dtf.vic.gov.au/sites/default/files/2018-02/state-budget-budget-overview-1999-2000.pdf

Figure 2

Source: https://www.dtf.vic.gov.au/sites/default/files/2018-02/state-budget-budget-overview-1999-2000.pdf

Of course, these numbers and the article postulate an impossible comparison between what actually happened and what might have happened had the assets remained in government ownership. It is clear from contemporary reports that the electricity industry was very inefficient before privatisation, and therefore it is likely that had it remained in government hands, either the realised EBITDA would have been lower or customer prices higher, if not both.

With respect to the State Government’s plan to bring back the SECV, the Office of the Regulator-General in 1998 stated that “overall service standards
in the electricity industry have been maintained or improved and that customers are now better off than they were under the SECV. Additionally, reliability improvements in the privatised distribution sector have meant that average Victorian customer minutes off supply have fallen from approx.. 510 minutes per year in 1989-90 to approx.. 150 minutes now. So much for SECV nostalgia!

Furthermore, the current outlook for Victorian state debt is eerily similar to the early to mid-1990s. Back then it was widely accepted that something needed to be done to address the problem. Fast forward and the state budget is forecasting net debt of $167.5 billion by 2025/26, 26.5 per cent of GSP. The re-establishment of the SECV will expose Victorians to more government debt and the risks associated with investment in the electricity generation sector, while also crowding out private sector investment.

Conclusion

For most of the last 25 years the privatisation of Victorian energy assets has been lauded by economists around the world as an excellent example of micro-economic reform through:

• Providing long-term value for the Victorian taxpayer against a counterfactual of retaining ownership;
• Resolving a serious debt crisis facing the Victorian government of the day, restoring its AAA credit rating and re-creating much needed confidence across the state economy;
• Freeing government capital to be used in parts of the economy less suited to the private sector, such as public health and education;
• Unlocking efficiencies within the energy sector that the government-owned sector had proved incapable of doing;
• Sharing these efficiencies between investors and customers through lower prices and better service.

It is then most disappointing that the 2022 state election campaign produced a new and false narrative against this well-deserved reputation. The election policy of re-introduction of government ownership was almost certainly motivated by electoral politics and ideology rather than evidence. However, the selective quoting of figures from one short article prepared outside government as justification for the policy is a sad reflection on the state of the Victorian polity.