Combatting climate change: let's try Plan D

Just as they say there's more than one way to skin a cat, so there are a lot of ways to reduce greenhouse gas emissions and "decarbonise" the economy. We've tried three ways so far, and now we may try a fourth.

The Rudd government tried to introduce an emissions trading scheme in 2009, but it was blocked in the Senate when the Greens joined the Tony Abbott-led opposition in voting it down.

When the Greens came to their senses, the Gillard government introduced a carbon tax in 2012, which it preferred to refer to euphemistically as "a price on carbon".

When Abbott came to power in 2013, he abolished the carbon tax and replaced it with "direct action" - using an emissions reduction fund to pay farmers and others to cut their greenhouse gas emissions.

But this week the government's Climate Change Authority recommended that the fund be supplemented by imposing an "emissions intensity scheme" on the nation's generators of electricity, so we could be sure of achieving the commitments the Abbott government made at the Paris climate conference last year.

Confused? Let me explain how an emissions intensity scheme would work and how it differs from its three predecessors. I think, given all the circumstances, it would be an improvement.

All four approaches are "economic instruments" which seek to use prices - rather than simple government laws about what we may and may not do - to encourage people to change their behaviour in ways the government desires.

Direct action just involves paying people to do things, whereas the other three are more sophisticated schemes, designed years ago by economists, to change market prices in ways that discourage some activities and encourage others.

Historically, economists have debated the relative merits of carbon taxes and emissions trading schemes, even though they are close relations.

If you look closely, however, you find that Julia Gillard's "price on carbon" was actually a hybrid of the two. It started out as a carbon tax because the government fixed the initial price at $23 a tonne.

But the plan was that after a couple of years, the price would be set free to be determined by the market, thus turning it into a trading scheme.

An emissions trading scheme - also called a "cap and trade" scheme - involves the government setting a limit on the total quantity of carbon emissions it's prepared to let producers emit, then requiring individual producers to acquire a permit for each tonne of carbon they let loose.

Producers who discover they're holding more permits than they need are allowed to sell them to (trade them with) producers who discover they're not holding enough.

The government would slowly reduce the number of permits it issued each year. This reduction in the supply of permits relative to the demand for them would force up their price.

The higher cost would be reflected in the retail prices of emissions-intensive goods and services, but particularly the prices of electricity and natural gas.

This, in turn, would encourage businesses and households to use energy less wastefully, as well as encouraging producers to find ways of reducing emissions during the production process.

The third scheme economists have invented, the emissions intensity scheme (a class of "baseline and credit" schemes), has similarities with emissions trading schemes.

The government takes the total emissions of an industry - in this case, the electricity industry - during a year and divides it by the industry's total production of electricity during the year, measured in megawatt hours, to give the industry's average "emissions intensity" - C0₂ per MWh.

Those producers within the industry whose emissions intensity exceeds this "baseline" must buy "credits" to offset their excess emissions, from those producers whose intensity is below the baseline, or face government penalties.

In practice, this would mean brown and black coal generators having to buy offset credits from combined-cycle gas, wind and solar generators, benefiting the latter at the expense of the former.

The Climate Change Authority recommends that the intensity baseline be reduced each year by a fixed percentage until it reaches zero "well before" 2050.

If the scheme began in 2018 and was to reach zero by, say, 2040, the baseline would have to be reduced by 4.5 per cent a year (100 divided by 22).

So the absolute size of the reduction in emissions required would be high in the early years, but get smaller over time.

A great political attraction is, whereas the other schemes raise the price of every unit of electricity, the intensity scheme just shifts costs between different parts of the industry, meaning the average price increase should be small.

There would be some price rise, however, because the production costs of renewable generators are higher than those for fossil-fuel generators, and the scheme would increase the proportion of renewable energy in total production.

Just how high the price had to go would depend to a big extent on the effects of further economies of scale and further advances in technology in reducing the average cost of producing renewable energy.

An economic advantage of the intensity scheme is that it wouldn't be open to trading permits with other countries' emissions trading schemes (especially the European Union's, where the carbon price has collapsed) nor to dodgy emissions credits from developing countries.

The main economic drawback of an intensity scheme is that, by not doing a lot to raise the price of electricity, it wouldn't do much to encourage businesses and households to reduce their demand for electricity.

To counter this, the authority proposes that generators needing to buy offset credits be allowed to meet their requirements by purchasing "white certificates" from existing state government schemes which offer incentives to firms that do things to reduce their power use.

Let's hope the new approach brings some action.

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Innovative idea would fix brown coal problem

Tony Abbott's decision to put short-term popularity ahead of the nation's longer-term economic interests by abolishing the carbon tax has left Malcolm Turnbull with more than a few problems. Just one is the likelihood that less-polluting power stations will close while more-polluting ones keep pumping out greenhouse gases.

At the Paris summit late last year, our government was shamed into promising to step up our reduction of carbon dioxide emissions, even though, without the carbon tax, we lack an economic instrument strong enough to bring the promised reduction about.

But we could make some progress if we could find an acceptable way of taking out of production the worst of Victoria's brown coal (lignite) power plants. The emissions per unit from these plants are about 50 per cent higher than for black coal plants.

The problem is explained in a paper by Associate Professor Frank Jotzo, of the Crawford School of Public Policy at the Australian National University, and Salim Mazouz, of EcoPerspectives.

Thanks to our less wasteful use of electricity and the growth in sources of renewable energy, we now have excess capacity to produce coal-fired power. Sooner or later, some power stations will have to close.

Trouble is, the absence of a price on carbon means there's no guarantee it will be the more-polluting brown-coal plants that bite the dust.

That's because brown coal-fired electricity is significantly cheaper to produce than black coal-fired power.

Why? Because the brown coal power stations are right next to the brown coal mines, thus minimising the cost of shipping the coal to the station.

And the brown coal itself is cheaper because there's nothing else to do with the stuff, whereas black coal could be exported to foreign power plants, which would pay well for it. (Black has a higher "opportunity cost".)

The lower cost of brown coal-fired power (lower "short-run marginal cost", in the jargon) means the brown coal stations do well in the continuous auction to sell power into the national electricity grid.

This means that, though the decline in demand for power from the grid has caused the level of production capacity use to fall for all types of power plants, the brown coal plants are still operating at about 70 per cent of capacity, compared with black coal plants at about 50 per cent.

That's more reason to fear that, if the question is left to be resolved by the market, the plants that close won't be the high emitters.

If we had a decent carbon tax – or emissions trading scheme, they're much the same thing – it would add more to the cost of brown power than it would to black power, so to speak, because its impost varies according the emissions-intensity of the product being taxed.

So, provided the tax was sufficiently high, it would push the firms in the market in the direction that was most desirable from the perspective of tackling climate change. Which, of course, is the reason you have a carbon tax.

But although various power stations aren't making adequate profits, there's little sign that any of them is close to throwing in the towel.

Why not? Because each of the potential quitters is telling themselves that, if they can only hang in there longer than a couple of the others, they'll get their cut of the departing firms' market share, meaning they'll then be in better shape.

Such a Mexican standoff is known to economists as a "collective action problem". The firms in a market have got themselves into a situation where they realise that something they're each doing is damaging to themselves and everyone else, but no particular firm is willing to be the first to stop doing the crazy thing because they fear their rivals would take advantage of them.

Many economists give you the impression competition is an unalloyed benefit. Collective action problems are an example of the downside of competition.

Which means they're an instance of "market failure" – circumstances where problems can't be solved simply by leaving it to the market. (Another instance of market failure is, of course, the damage to the climate caused by greenhouse gas emissions.)

The existence of market failure establishes the case for government intervention in the market – provided you can be confident the intervention will make things better rather than worse.

Intervention by the government is pretty much the only solution to collective action problems. The government comes in over the top and imposes a solution equally on all the firms in the market, which go away pleased they no longer feel obliged to do the crazy thing.

Here's the point: Jotzo – an environmental economist of international stature – and his colleague have proposed an ingenious, innovative, agile solution to the brown coal problem, one that would cost the government and the taxpayers nothing.

You invite the four brown coal power producers to enter an auction by nominating the minimum amount they'd need to receive to be willing to close down. You'd pick the winner or winners according to the ones that offered the cheapest cost per unit of emissions reduced.

You'd be hoping the winners were Hazelwood, owned by GDF Suez, the oldest and most emissions-intensive generator, and Yallourn, owned by Energy Australia, the second oldest and second most emissions-intensive generator.

But the government wouldn't just hand over a cheque. Rather, it would recover the cost by imposing a levy on all the remaining black and brown power plants – those that would benefit from the closures – in proportion to their emissions.

It's true the remaining power stations would want to pass that extra cost on to their customers. But because distribution costs (poles and wires) are so great, the (higher) wholesale price is only a small part of the retail price, meaning the effect on households is likely to be small.

Not a bad idea.

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A rational analysis of Hockey's 'asset recycling'

I'm never sure who annoy me more, the business types who are certain every business is better run if privately owned, or the lefties who oppose every sale of government-owned businesses on principle.

On the question of privatisation, mindless prejudice is no substitute for rational analysis of the pros and cons. On the tricky question of the "asset recycling" being promoted by Joe Hockey to all state governments with businesses left to sell, careful analysis is essential.

Premier Mike Baird's hugely controversial proposal to sell most of NSW's electricity transmission and distribution network businesses – the "poles and wires" – and use the proceeds to finance $20 billion worth of public transport, road and other infrastructure is a classic example of asset recycling.

It offers a good case study in thinking through the issues, even to people who won't be voting in Saturday's state election.

You must cover all the relevant major considerations for and against, ignoring considerations that aren't relevant (or are common to both alternatives). You have to remember to take account of opportunity costs as well as actual costs and to avoid any double counting.

It will avoid confusion if we consider the two sides of the proposition separately. First, is it a good idea to sell the poles-and-wires businesses to private owners? Second, assuming the planned infrastructure projects are worthwhile, is privatising businesses the only way available to finance them?

The obvious starting point for consumers is: would selling the businesses lead to electricity prices being higher than they would be under continued public ownership? Or would there be a decline in the quality of service, such as blackouts?

In this particular case, the answers are more certain than usual: no and no. That's because, the networks being natural monopolies, the prices they charge are controlled by the Australian Energy Regulator, which believes they're already too high. Service quality is also tightly regulated.

The regulator's determination to get efficiency up and prices down suggests there will be job losses – in other states as well as NSW – whether or not the businesses are privatised.

This being so, the main issues of contention concern state government finances. The critics of privatisation stress that it's no magic pudding: sell these profitable businesses and you lose the dividends they were paying the government, along with the equivalent of the company tax they were paying to the state (because state-owned businesses don't pay tax to the federal government).

That's obviously true. But remember that, according to economic theory, the sale price of any business should be the "present value" of the stream of income it's expected to earn in coming years.

If so, the seller is perfectly compensated in the sale price for the loss of future dividends. Why else would they sell?

But does the theory work in practice? Not perfectly. For one thing, who can be sure what income will be earned in the future? The seller ought to have a better idea than the buyer, but if there aren't many potential buyers and the seller is anxious to sell, they may settle for less than they should.

Alternatively, if there are a lot of potential buyers, the seller may get more than the business is worth. Almost all buyers of established businesses are confident they can run it more profitably than the present owner.

Point is, provided the sale price is adequate, there's no financial reason to regret the loss of dividends. A complication is that a fair price would not compensate the state government for its loss of tax equivalent payments.

That's because a new private owner would be liable to pay real company tax to the federal government. This is part of the rationale for Hockey's scheme to give federal grants – $2 billion, in this case – to states that take part in his asset-recycling incentive scheme.

A factor having a bigger (downward) influence on the amount of the fair sale price is that the flow of annual profits from the network business in coming years is likely to be much lower than the recent $1.7 billion a year that Labor's Luke Foley keeps quoting.

That's partly because the regulator has signalled its intention to crack down on the excessive profits being earned by the nation's electricity network businesses, but also because the demand for electricity from the grid is falling and will fall further as people move to solar and the introduction of smart meters helps homes and businesses limit their demand for power.

(This demonstrates the economic truth that natural monopolies are a product of the existing technology. The network businesses' monopoly is being eroded by climate-change-driven technological advance.)

Some critics argue that selling profit-making assets and replacing them with roads and loss-making public transport reduces the state government's "net worth" and weakens its balance sheet.

This is true arithmetically, but is a strange argument. Governments aren't profit-seeking businesses. Their job is to meet the social and economic needs of their community by, among other things, ensuring the provision of adequate infrastructure – directly profitable or otherwise.

Turning to the predicated link between the sale of network businesses and the spending on needed infrastructure, it rests on an assumption it would be unthinkable for the state government to lose its AAA credit rating, which would happen if it simply borrowed another $20 billion.

For decades, federal and state treasuries have used credit ratings to beat off unworthy proposals for vote-buying capital works. But I think we have little to lose by causing the discredited rating agencies to lower our rating by a notch or two.

But though their limit on our debt level may be too low, there does have to be some safe limit. And the doctrine that state governments may acquire assets but, once acquired, they may never ever be sold off, strikes me as weird.

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Poles and wires: who's misleading us about what

The politicians' decades of bad behaviour may have caused them to lose our trust, but not our mistrust - making us suckers for scare campaigns.

This election campaign has been dominated not by reasoned debate but by Labor and the power unions' almighty scare campaign over the sale of the state's electricity poles and wires.

It's the most successful scare-job since all the dishonest things Tony Abbott said about how the carbon tax would destroy the economy.

The truth is it doesn't matter much to electricity users whether the state's power transmission and distribution businesses stay government-owned or are sold off. That's because, being natural monopolies, the prices they charge are controlled by a national body, the Australian Energy Regulator.

The standard of service they deliver - blackouts, for instance - is also tightly regulated.

It is true that private owners would attempt to increase their profits by reducing overstaffing and other inefficiencies - which tells you what the power unions are so excited about - but the regulator has announced its intention to force all the nation's public and privately owned poles and wires businesses to raise their efficiency and to ensure the savings are passed on to consumers as lower prices.

It's clear that, whoever owns the poles and wires, those businesses will be doing it much tougher in coming years. That's because the demand for electricity from their grid will keep falling, with households and businesses moving to solar and the introduction of smart meters helping households cut their usage, especially at peak periods.

This is why the dividends the state government would lose by selling the businesses would be a lot lower than the present $1.7 billion a year Luke Foley keeps claiming. (A characteristic of scare campaigns is that you stick to your wrong claims even after you've been caught out.)

This is not to say we can believe everything Mike Baird has been saying, of course. He describes his plan as "the long-term lease of 49 per cent of the NSW electricity network". This is highly misleading, an attempt to fool us into believing he isn't really privatising the network.

There's little practical difference between a 99-year lease and an outright sale. And that figure of 49 per cent - making it seem the government would retain majority ownership of the network - is highly contrived.

Baird plans to sell 100 per cent of TransGrid, the state-wide high-voltage transmission business, and 50.4 per cent each of Ausgrid and Endeavour Energy - which distribute power locally to about 70 per cent of the state's population living between Ulladulla and Newcastle, and inland to Scone, Lithgow and Bowral.

How does that add up just 49 per cent? By taking account of the plan not  to sell any of Essential Energy, which distributes power to the state's backblocks. Convinced?

A separate question is: is selling the electricity network the only way we would be able to fund the $20 billion in new public transport, road and other infrastructure Baird promises?

Yes - if you think it matters that the state keeps its triple-A credit rating. No - if you don't. I don't.

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Privatisation: neither very good nor very bad

The era of privatising government-owned businesses is pretty much done and dusted, but two governments have dragged their feet, making opposition to their efforts to complete their privatisation programs a key issue in the Queensland election last week and the NSW election next month.

Voters have always disapproved of privatisation, but that hasn't stopped a lot of it happening. Particularly in recent years, however, voters' doubts have been fed by the dire predictions of those unions whose members fear they will be adversely affected. Let private owners loose and prices to consumers will skyrocket!

So what evidence is there that the prices charged by privatised businesses are higher than those of government-owned businesses? And where's the evidence that privatisation is good for the economy, anyway?

Malcolm Abbott, of Swinburne Business School, and Bruce Cohen, of the Grattan Institute, have conducted a meta-analysis (a study of studies) of the effects of privatisation in Australia, published in the latest issue of the Australian Economic Review.

If you're surprised to learn that most of what could be privatised already has been, and that most of it happened quite a while ago, let me quote their facts and figures.

They estimate that the sale prices of all the privatised businesses since 1987 total $194 billion. The bulk of those sales occurred in the 1990s. The federal government accounted for just over half that total, with Victoria taking a quarter and NSW and Queensland 7 per cent each, with South Australia and Western Australia making up the remaining 8 per cent.

Broken down by industry, communications (mainly Telstra) accounts for a third of the total proceeds, electricity for a quarter, financial services (Commonwealth Bank, state banks and state insurance offices) for 15 per cent, aviation (Qantas, Australian Airlines and many airports) for 9 per cent, gas for 8 per cent and, among the tiddlers, gambling (TABs and lotteries) for 2 per cent.

One thing this list proves is that though many people disapprove of selling off government businesses, once it has happened we get used to it pretty quickly.

The stated reasons for believing privatisation to be a "reform" vary. For the Howard government, the attitude was: "Everyone knows privately owned businesses are better managed than government-owned, so why not sell our businesses and use the proceeds to reduce debt?"

A more sophisticated rationale is that deregulating an industry to foster competition in it is far more important in encouraging productive efficiency (higher productivity) and better service to consumers. Once that greater competitive pressure has been achieved, you might as well sell the business you own and use the proceeds for some more beneficial purpose.

So what do all the studies tell us about how the great privatisation experiment has worked out? The evidence is, in the authors' words, "far from conclusive". Despite the extensive privatisation that has occurred, only a limited amount of research has been undertaken.

In the case of government-owned banks, the industry had been extensively deregulated before they were sold. Their productivity did improve, but not until long after they had been sold.

And it's hard to know how much this improvement was because of deregulation and greater competition, rather than privatisation.

I think it's still true that the banks' interest margin - the gap between what they pay to borrow and what they charge to lend - is lower than it was before deregulation. I doubt if privatisation has made much difference to this.

In the case of aviation, the government deregulated its two-airline policy well before it allowed Qantas to take over Australian Airlines and then be privatised. I don't think there's much doubt that domestic air fares have been lower than they would have been had deregulation not occurred.

The lower international air fares are explained by privatisation and deregulation in many countries, combined with the advent of bigger, more cost-effective planes.

The process of deregulating telecommunications, including the admission of new competitors such as Optus and Vodafone, began long before the staged privatisation of the former monopolist, Telstra.

I think the sale of Telstra could have been done in a way that did more to promote competition - no doubt at the cost of a lower sale price for the monolith - but there's little reason to believe privatisation has made prices higher than otherwise or reduced productive efficiency.

Of course, the spread of mobile phones and use of the internet have transformed the telecom industry. Distance phone calls are cheaper than they've ever been. Technological advance explains most of this, but increased competition would have helped.

It's a similar story with electricity. It's the break-up of the old state-by-state monopolies, the introduction of competition and the formation of the national wholesale electricity market, much more than privatisation, that's done most to affect the efficiency of the industry and the prices we're paying.

Most of us have forgotten the big real price falls achieved in the 1990s, even before the major reforms took place. The more recent series of big price rises occurred despite the success of the national market in holding down wholesale prices.

The rises were caused by failure in the regulation of prices charged by the privately and publicly owned monopolies responsible for distributing the power (the "poles and wires"). But this failure has been corrected and the distribution component of retail prices is likely to fall now.

Studies suggest that, in competitive markets, whether businesses are publicly or privately owned makes little difference. It follows that consumers have little to fear from privatisation in electricity.

So how would new private owners make room for the profit they seek if they have little scope for lifting prices? By removing any remaining overstaffing and workers' perks.

That's why the unions are running scare campaigns about soaring prices.

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Rationalists should stop burying their mistakes

I'm not a great proposer of royal commissions, but maybe such a spotlight is the only way to oblige blinkered economic rationalists to face the many failures of their knee-jerk advocacy of outsourcing, privatisation and deregulation.

Economists aren't as scientific as they claim to be, being prone to what psychologists call "confirmation bias". Whereas the scientific method requires you to seek disproof of your theory, economists - like the rest of us - note all the occasions when it seems to work and quickly forget any times when it didn't.

But, as the troubles of the for-profit trainer Vocation remind us, the instances of ill-considered micro-economic reforms producing dubious outcomes just keep piling up.

One class of reform that sounds fine in theory but often performs badly in practice is the outsourcing of government services. The theory says that just because some service has public-goods characteristics - it can't be provided profitably by the private sector in adequate quantity - and so must be provided at taxpayer expense, that doesn't mean it has to be delivered by public servants.

Why not get the best of both worlds by contracting outsiders to deliver the service on the government's behalf? You can call tenders and so ensure the government discharges its obligations at the keenest price. Often it will be charities and community organisations that are most interested, but why exclude for-profit businesses if they can offer a better price than the not-for-profits?

There's little doubt governments - and businesses, for that matter - have made significant savings by outsourcing particular functions. Sometimes this is because the contractor has access to economies of scale or scope not available to the outsourcer.

But I doubt if many savings arise purely from greater efficiency - especially not when profit margins have to be accommodated. No, usually the savings arise from side-stepping existing staffing levels, wage rates and conditions.

Often, the service is now provided using fewer, less-well remunerated workers, maybe with more casuals.

In which case, the saving may well come at the cost of a loss of quality - one the advocates of outsourcing aren't anxious to know about. The risk is greater if the contractor is also making room for his profit.

The advocates tell you it's all a matter of writing watertight contracts, but sensible people know that's not possible. They also know motivations count for more than legalities.

Why can I think of no thorough-going evaluations of the costs and benefits arising from outsourcing? It's not hard to call to mind a lot of examples where outsourcing to the profit sector has come scandalously unstuck.

Consider all the stuff-ups we've had with public-private partnerships for the construction and operation of infrastructure. The cases where seemingly reputable private consultants have grossly overestimated the number of motorists who'll use a tunnel, bridge or highway.

Even when these partnerships don't blow up, you often find the government has agreed to tie its hands on future road and even public transport options to make the deal attractive to the private partner. A hidden cost.

Consider the disaster when the authorities who'd recommended that private firms be allowed to deliver heavily subsidised childcare sat back as the deluded principal of ABC Learning took over half the nation's childcare centres before everything collapsed.

Consider the many foreign students ripped off by shonky trainers permitted by lax regulators to, in effect, sell the right to become permanent settlers.

Broadening the focus, remember when the Hawke government handed control of the wool reserve price scheme over to the industry, which eventually sent it broke. Remember the trouble when the Kennett government thought it was smart selling power stations for far more than they were worth.

Remember the Keating government privatising our monopoly airports and now, we discover, sweetening the deal by giving the owner of Sydney airport first refusal should a second, potentially competitive airport ever be built.

Remember the way some states sold their monopoly electricity networks, but our price-regulation regime failed utterly to stop the private owners badly overcharging power users.

Note how often customers and taxpayers have had to pay to clean up the mess created by micro-economic reformers who know a lot about theory but far too little about how the profit motive works in practice.

And where's the rationalists' learning curve? Where's the evidence they've learnt from 30 years of cock-ups? When will they learn respect for the terrible power of profits?

When will they learn that when the public sector plays poker with the private sector in a commercial-in-confidence back room, it's almost always the pollies and econocrats who emerge without their shirts?

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Mixed progress on reform of power prices

Do you think you're paying too much for electricity? Would you like to see an end to hefty annual price rises, maybe even a fall in prices that goes beyond the abolition of the carbon tax? Well, be patient. The econocrats are working on it.

It may surprise you that they've been in the process of reforming electricity prices for the best part of 20 years, and they're far from finished. They got part of the power system working well, had a bad slip with another bit, and the jury's still out on a third. But they're working away and are confident of success - eventually.

The national electricity market - covering all of Australia bar Western Australia and the Northern Territory - is actually a creation of our econocrats, their grand experiment in market competition.

Before this, we had separate, state-owned monopolies that charged us pretty much what they wanted to charge, particularly because our demand for power kept growing every year. The reformers' bright idea was to link up all the eastern and southern states and turn them into a market by making all the individual power stations compete to feed electricity into the national grid at the lowest prices possible.

Buying the power at the other end of the grid would be various electricity retailers, which would deal directly with households and business users. These, too, would be required to compete with each other to win our business, since we'd be free to buy our power from whichever retailer we chose.

Linking the power stations in the wholesale market with the retailers supplying power to you and me would be the high-voltage transmission and lower-voltage distribution network (the "poles and wires", as pollies keep calling it).

Since it would never be economic to build rival networks, this would have to stay as a monopoly. And being a monopoly, whether it was sold off or remained government-owned, the prices it charged the retailers - and they passed on to us - would need to be closely regulated to prevent rip-offs.

The reform of the first part of the system has worked really well. Competition between the electricity generators has been cut-throat, prices haven't changed much over the years and no power stations are making excessive profits.

But the cost of generating the electricity makes up only about 30 per cent of the retail prices we pay. The big problem has been that faulty rules have prompted the regulators of the network operators' charges to grant them excessive increases, to the point where "network charges" now explain about half of retail power prices.

It's five years of these big increases, much more than the carbon tax or the renewable energy target, that have caused retail prices to grow so fast. A big part of the problem is that, about four years ago, the demand for electricity, which had been growing every year for a century, stopped growing and started falling.
It fell mainly because of new laws requiring appliances to be more efficient in their use of power and because all the fuss Tony Abbott was making about the price of electricity prompted us to be more price-conscious and look for ways to reduce our usage.

The network operators began investing heavily to improve the capacity of the network to meet the ever-higher peak demand for power on hot summer afternoons when a growing number of us had airconditioners going full blast.

One small problem: the fall in annual demand for electricity meant the brief seasonal peak had stopped rising. For several years the industry refused to believe the downturn in demand from the network was more than a blip.

So we've expanded the capacity of the network beyond what we're likely to need for some time. But you and I are paying extra for this expansion and will continue paying until it's paid off.

The good news is the econocrats have finally woken up to the problem. Actually, they were woken up in 2012 by the fuss Julia Gillard made when she realised Abbott was framing her for price rises she didn't cause.

In 2012 the rules were changed to give the regulators greater power to limit increases in the network charges passed on to retailers. Such changes take far longer than you'd imagine to flow through, but from now on it seems likely the network component of retail electricity bills will stay fairly steady in dollar terms.

The econocrats have proposed a further reform which, when it takes effect, will require the networks to bill retailers according to the time of day and time of year when you and I use electricity. With the spread of "smart meters" - which show the precise times when each household uses its electricity - we'll be charged according to our time of use, with those of us who show restraint during peak periods paying less, and those who don't paying more. This should produce a lasting solution to the (expensive) problem of ever-rising peak demand on hot afternoons.

That leaves the question of the effectiveness of competition between the growing number of electricity retailers, big and small. Here the jury is still out. Much depends on how smart we are in finding the retailer offering the best deal - on which quest I offer some tips in my little online video spiel.

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Many reasons for the impossible: power demand falling

We know the two great certainties in life are death and taxes, but many thought there was a third: the inexorable rise in consumption of electricity. As the population grew and each of us got a little more prosperous each year, we'd use more power. The mighty electricity industry was built on that certainty.

Except that electricity consumption has been falling for the past four years. To say this has taken the industry by surprise is an understatement. For well over a century – even during the Great Depression – the quantity of electricity used in Australia each year was greater than the year before.

It took the industry and its regulators two or three years to accept the trend was more than just a hiccup on the ever-upward path, which delay probably added to the decline.

There are few aspects of the economy – global or national – where change is more significant, more diverse or more interesting than energy supply and demand – where energy covers coal, gas (conventional and unconventional), petroleum, wind, solar and other renewables. Expect to hear more from me on the topic.

But there are few questions more interesting than exactly why the unthinkable, a fall in electricity consumption, has come about. Short answer: a surprisingly large combination of reasons, although Tony Abbott's crusading against the carbon tax must get some of the credit.

The best attempt to quantify the various factors involved comes from a report prepared by Dr Hugh Saddler, an energy expert with the Pitt and Sherry consultancy, for the Australia Institute. Saddler's modelling covers the years to 2012-13, but we know from reporting this week by Origin Energy and AGL that the fall continued in 2013-14.

Saddler focuses on energy produced and consumed from the National Energy Market, which covers the five eastern states and the ACT, but the decline is occurring also in Western Australia. After peaking in 2008-09, consumption from the national market in 2012-13 was down by almost 8 terawatt hours, or 4.3 per cent.

But that's only half the story. Just as important as why demand has fallen is why it hasn't continued growing, as continued growth in the population and the economy would lead us to expect. Saddler estimates that had demand continued growing from 2004 at its average rate of growth over the previous 20 years (2.5 per cent a year) it would have been 37 terawatt hours more than it actually was in 2012-13.

This shortfall is equal to the output of almost 5000 megawatts of coal-fired generation capacity, the combined capacity of the Bayswater and Eraring power stations in NSW, or Loy Yang A and B and Hazelwood in Victoria.

"All of the decline in consumption has been at the expense of coal-fired generators, with the result that many are now barely profitable," Saddler says.

Greenhouse gas emissions fell by 9.2 megatonnes of carbon dioxide equivalent, about 2 per cent of Australians total annual emissions.

So what has caused our power consumption to fall rather than rise? The biggest single reason is the introduction from the late 1990s of regulations to increase the energy efficiency of refrigerators, freezers and many other residential and commercial appliances, and to increase the energy efficiency of new buildings.

Saddler estimates this explains 37 per cent of the 37 terawatt-hour shortfall from what might have been.

The next biggest part of the explanation is structural change in the economy away from electricity-intensive industries. Over the year to September 2012, three major NSW industrial power users – Port Kembla steelworks, Kurri Kurri aluminium smelter and the Clyde oil refinery – were partly or completely shut down. This explains 10 per cent of the 37 terawatt-hour shortfall.

The evidence also suggests that power consumption by other major industrial users has been little changed over the three years to 2012-13. Saddler estimates that this failure to grow explains a further 14 per cent of the shortfall, taking the total contribution from structural change to almost a quarter.

The next most important part of the explanation is the response of electricity users, particularly residential users, to the higher prices they were being charged. Saddler finds that after 2010 there was "an abrupt change in consumer responsiveness to higher prices".

This was the time when the possible effect of a carbon tax on electricity became a major political issue thanks to the efforts of Abbott and his "sceptic" mates. At the time, retail electricity prices were rising spectacularly, mainly because of a huge increase in spending on upgrading the transmission and distribution networks (poles and wires) to cope with an expected ever-rising peak demand on hot summer afternoons.

Saddler finds evidence to support his argument that all this carbon-tax-related fuss about the high cost of electricity caused many households to be a lot more conscious of what was happening to their power bills and to respond by finding ways to cut their usage – to the extent that they "have managed to completely offset the effect of higher prices on their household budgets by reducing consumption".

This highly unusual jump in the short-run "price elasticity" of electricity explains 19 per cent of the shortfall, he estimates.

He further calculates that the growth in output from rooftop photovoltaic solar and other small, distributed generators accounts for about 13 per cent of the shortfall. This, of course, is a fall in the demand for electricity supplied by the major, mainly coal-fired generators, not a fall in the use of electricity as such.

Saddler notes that for the past three years the annual peak demand has been falling, not increasing, despite the huge investment to cope with ever-rising peaks. When will this additional capacity, which is now built and for which all electricity consumers are paying – and will continue to pay for some years to come – be required, if ever, he asks.

Good question.

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Modellers bamboozle over cost of renewable energy

There's a lot of public support for the renewable energy target, which requires electricity retailers to get 20 per cent of their power from renewable sources by 2020. But now the country's being run by climate change "sceptics", let's get with the program. Forget the threat of climate change, stop worrying about your grandchildren and focus on what matters most: what this do-gooder scheme is doing to your cost of living.

Although before the election Tony Abbott professed support for the target, since the election he has instituted an expert review of it, headed by businessman Dick Warburton, former chairman of Caltex and prominent "sceptic".

The review commissioned a leading firm of economic consultants, ACIL Allen, to undertake modelling on the future effects of the target.

The preliminary report found that, between 2015 and 2020, the target would increase the average household electricity bill by $54 a year - a tad over $1 a week. This five-year average, however, conceals the estimation that the cost of the scheme will fall as each year passes.

So by 2020 itself, the increase will have reduced to just $7 a year. By the end of another 10 years, in 2030, the scheme is estimated to be actually reducing average household electricity bills by $91 a year, or $1.75 a week.

It's common sense that requiring electricity retailers to buy a certain proportion of their power from more expensive renewable sources - mainly wind power, but also solar - would add to the cost of their power, with the extra cost being passed on to consumers.

So why has ACIL Allen's modelling concluded the target will add to the price of electricity initially, but eventually subtract from it? The short answer is because electricity pricing is a complicated business.

It turns out that adding to the supply of renewable energy available reduces the wholesale price of electricity. This is because the price being paid for energy being put into the national electricity grid by particular generators varies minute by minute according to the balance of supply and demand.

In the middle of the night, when little power is being used, the wholesale price is very low. But on a cold evening - or, more likely these days, a very hot afternoon - the wholesale price can be stratospheric.

The trick to renewable energy is that it tends to be available when the demand for electricity is high. Experience around the world confirms the Australian experience that renewable energy does a great job of reducing spikes in wholesale prices on very hot and very cold days.

Another part of it is that though it costs a lot to build wind and solar generators, once they're built there are few "variable" costs. Wind and sun are free; coal and gas aren't. So the renewable generators offer to supply power to the grid at very low prices and this lowers the prices the coal and gas generators are able to ask for.

But none of this changes the fact that the electricity retailers have to pay for the "renewable energy certificates" that the target scheme requires them to buy. These certificates reduce the capital cost of setting up the wind and solar generators whose operations then reduce the wholesale cost of power.

So it turns out the renewable energy target scheme has the effect of reducing the wholesale cost of electricity while also adding to the costs of the electricity retailers. ACIL Allen's modelling suggests that, for the next five years, the extra retail cost will exceed the saving in wholesale costs, but after that the saving will exceed the extra cost.

See what this means? The case for saying we must get rid of the renewable energy scheme because it's adding too much to the living costs of struggling families has collapsed.

But there's where the story takes a twist. Modelling of the future cost of the renewable energy target, published by an equally prominent firm of economic consultants, Deloitte, comes to opposite conclusions.

Deloitte's modelling accepts that the renewable energy scheme is reducing wholesale costs, and roughly confirms ACIL Allen's finding about the higher cost to household customers until 2020. But whereas ACIL Allen expects the scheme to start reducing household costs after that, Deloitte expects the cost to stay positive until 2030, causing household bills to be between $47 and $65 a year higher than if the scheme was scrapped.

Why have two leading economic consultants reached such opposing conclusions? Perhaps because Deloitte's modelling was commissioned by the Chamber of Commerce and Industry, the Business Council and the Minerals Council.

Deloitte doesn't conceal that its modelling is in reply to ACIL Allen's. Would it surprise you if the fossil fuel industry wanted to see the renewable energy target abolished and was alarmed to know that modelling commissioned by the review had demolished the argument that continuing the target would add to people's electricity bills? Now the review will be able to pick whichever modelling results it prefers.

How did Deloitte reach such different results? By feeding different assumptions into its model. It seems to have assumed the cost of wind farms won't fall over time (which it probably will), whereas the price of gas for gas-fired generators won't rise much (which it already has).

Regrettably, economic modelling has degenerated into a device for bamboozling the public.

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Carbon tax not real reason for soaring power prices

Tony Abbott is right about one thing: the price of electricity has shot up and is now a lot higher than it should be. It's a scandal, in fact. Trouble is, the carbon tax has played only a small part in that, so getting rid of it won't fix the problem.

Until a rotten system is reformed, the price of electricity will keep rising excessively, so I doubt if many people will notice the blip caused by the removal of the carbon tax. (As for the price of gas, it will at least double within a year or two, as the domestic price rises to meet the international price, making the carbon tax removal almost invisible.)

So Abbott will be in bother if too many voters remember all the things he has said about how much the tax was responsible for the rising cost of living, how much damage the tax was doing to the economy and how much better everything would be once the tax was gone.

He would be wise to change the subject and join the push to reform the electricity pricing arrangements.

A new report by Tony Wood and Lucy Carter, of the Grattan Institute, Fair Pricing for Power, says that over the past five years the average Australian household's electricity bill has risen by 70 per cent to $1660 a year.

And this has been happening while the amount of electricity we use has been falling, not rising. Just why electricity demand has been falling is a story for another day.

The cost of actually generating the power accounts for 30 per cent of that total. The cost of delivering the power from the generator to your home via poles and wires - that is, the electricity transmission and distribution network - accounts for 43 per cent of the total.

That leaves the costs of the electricity retailer - the business you deal with - accounting for 13 per cent of the total bill, with the carbon tax making up 7 per cent and the various measures to encourage energy saving or use of renewables making up the last 7 per cent.

Of these various components, the one that does most to account for the rapid rise in overall bills is the cost of the physical distribution network. Whereas there's fierce competition between the now mainly privately owned power stations, the network businesses - still government-owned in NSW and Queensland, but privatised in Victoria and South Australia - are natural monopolies.

This means the prices the networks are allowed to charge - whether government or privately owned - are regulated by government authorities. And this is the source of the problem. Loopholes in the price regulation regime have made it easy for the network businesses to feather their nest at the expense of you and me.

Why would a government-owned network business want to overcharge? Because their profits are paid to the state Treasury, which needs all the cash it can get. So the NSW and Queensland governments gain by looking the other way while their voters are ripped off. The gouging hasn't been nearly as bad in privatised Victoria, where electricity prices are well below the national average.

An earlier report from the Grattan Institute identified four main faults in the system used to regulate the prices of network businesses: the pricing formula allows excessive rates of return, considering essential monopolies are low-risk; government ownership leads to excessive investment in infrastructure and reduced efficiency; reliability standards to prevent blackouts are wastefully high; the pricing formula rewards investment in facilities you don't really need.

The various combined state and federal regulatory bodies have belatedly begun attempting to fix these problems, but they could do a lot more if the politicians prodded them harder.

Meanwhile, the latest Grattan report proposes a solution to one aspect of the over-investment problem: coping with peak demand. The trouble with electricity networks is that, if you want to avoid blackouts, the network has to be powerful enough to cope with the periods when a lot of people are using a lot of electrical appliances at the same time, which these days is a hot afternoon.

Over the course of a year, these occasions are surprisingly few, so you end up having to build a lot of capacity, which is expensive, but then is rarely used. It would make far more sense to encourage people to avoid such extreme peaks in their demand.

The way the pricing system works at present, however, is that far from discouraging people from buying airconditioners and turning them on full blast on very hot afternoons, they're subsidised by those householders who don't.

The simple answer would be for the part of people's bills that relates to their share of network costs to be changed from charging for how much power they use to a capacity-based charge. That is, they pay according to the maximum load they put on the network in peak periods.

The result would be to remove the subsidy between high and low-capacity users, increasing or reducing their bills by up to $150 a year.

The greater benefit would be the price signal sent to high-capacity users to reduce their use of appliances during peak periods and save. As people responded to this incentive, the need to keep adding to the network's capacity would fall, thus reducing the need for higher electricity prices.

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Ignoring climate change will cost the economy

Sometimes I fear Australia has decided to go backwards just as the rest of the world has decided to go forwards. Take climate change. If the repeal of the carbon tax gets through the Senate this week there will probably be celebrations in the boardrooms of all the business groups that lobbied so hard for its removal.

But if they imagine the lifting of this supposedly great burden on them and the economy will mean it's back to business as usual, they'll soon find out differently.

They may have rolled back the economic cost of doing something about climate change, but now they'll face the increasing cost of not doing something about it. As Martijn Wilder, an environmental lawyer with the Baker & McKenzie law firm, finds in a new report for the Committee for Economic Development of Australia, we're going to be hit from all sides.

There are the costly physical effects of climate change we've already started experiencing, there are the consequences for us of measures our trading partners are starting to take to limit their emissions, there's the growing reluctance of foreign institutions to fund new coalmines and power stations and there's the threat to our fossil fuel industries from ever-cheaper renewable energy.

In case anyone's forgotten, Wilder reminds us that the physical effects of climate change include a rise in the sea level, acidification of the ocean, change in rainfall patterns and an increase in the frequency of natural disasters, including droughts. Extreme weather may lead to more bushfires, while heavy rainfall and cyclones may lead to flooding.

Do you think all that generates no costs to business, no disruption to the economy? Take the Queensland floods in 2011, Wilder says. They not only hit insurance company earnings, they also halted production at various coalmines. This forced up world coal prices, with adverse effects for industries reliant on coal.

Since we've always had cyclones and floods, no one can say climate change caused this particular disaster. But the scientists tell us events such as these will become more frequent. And the insurance industry's records tell us the number of catastrophic weather events is already increasing, with the economic losses associated with weather rising.

As for the idea there's no hurry in preparing for problems that may not become acute until later this century, consider this. Had a levee to protect Roma, in Queensland, been built in 2005, it would have cost $20 million. Since it wasn't built, $100 million has been paid out in insurance claims since 2008 and a repair bill of more than $500 million incurred by the public and private sectors since 2005.

This sort of thing is happening in other countries, too. Hurricane Sandy, in October 2012, caused widespread damage in New York, crippling electricity infrastructure and leaving downtown Manhattan without power for four days. The record-breaking storm surge alone cost the local electricity company $500 million and New York businesses $6 billion.

Perhaps such events explain why many other countries are moving forwards rather than backwards in their efforts to combat climate change. Australia's coal and natural gas industries won't escape being affected by tougher regulation of the use of fossil fuels in the countries to which they export.

While Europe has had a weak emissions trading scheme since 2005, the Chinese are trialling such schemes in six provinces. South Korea, one of our main trading partners, is to introduce a scheme next year. The US is taking direct action to cut power station emissions.

China is moving to limit coal to 65 per cent of energy consumption by next year and has banned new coal power generation in Beijing, Shanghai and Guangzhou. Wilder says this will cut demand from the largest importer of Australian coal and thus affect the value of big mining and loading assets in Australia.

The more the rest of the world seeks to reduce its use of coal and other fossil fuels, the more Australian businesses need to contemplate the possibility of their mines becoming "stranded assets" - assets that suddenly become unprofitable and so lose their value.

Until recently, foreign investors and financiers haven't taken climate-change risk into account. Now they're starting to worry not just about the morality of emitting more greenhouse gas, but the risk that investments in new mines and power stations will lose their value before they reach the end of their useful lives. The change started with international agencies such as the World Bank, but is spreading to pension-fund investors.

Then there's the threat from the rise of renewable energy. China's goal of becoming a world leader in renewable energy has made it the world's largest maker of renewable energy equipment and the single largest destination for investment in renewables.

Wilder says renewables are reaching a "point of disruption" and will displace coal and gas power stations in many parts of the world. In Australia, the sharply rising price of gas is increasing the cost-competitiveness of renewables.

"Unlike natural gas and coal, the input for renewable energy is not subject to the volatility of global energy markets and with renewable costs continuing to decline, renewable generation represents a safer long-term investment," he says.

I know, let's get the government to put the kybosh on renewables. That would be a smart move.

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Ulterior motives abound in privatisation push

The trouble with the latest round of state government privatisations is that those who oppose them do so for the wrong reasons, but their promoters are also pushing them through for the wrong reasons.

Joe Hockey's 15 per cent incentive payment to encourage "asset recycling" - selling existing government-owned businesses to fund the building of new infrastructure - has fallen on receptive pockets in the NSW and Queensland governments, which are worried about their credit ratings and, unlike the Victorian government, still have valuable electricity transmission and distribution businesses to flog off.

The previous, Labor government in NSW tore itself apart over electricity privatisation, with the cabinet supporting it but the powerful public sector unions bitterly opposing it. It wasn't much better with the previous, Labor government in Queensland.

Now Labor is free of the responsibilities of office, it will be completely united in its opposition and its unceasing claims that privatisation will lead to big rises in electricity prices.

Since voters in all states strongly oppose privatisation, Labor will hope to do well with this argument at the NSW election in March. But polling also shows voters are much less opposed when the sale of businesses is linked to the building of specific new projects.

Labor's counter-argument is deceptively simple: government-owned businesses act in the best interests of their customers, whereas privately owned businesses seek to maximise their profits by raising their prices.

The truth is far more complicated than that. Whether publicly or privately owned, the monopoly business that doesn't seek to overcharge its customers has yet to be discovered by archaeologists. Monopolies that don't seek to maximise profits usually succumb to overstaffing and overpaying workers and managers. Why wouldn't they?

The public sector unions understand this full well, which is their real reason for opposing privatisation so vehemently.

They know that whether or not the private owner succeeds in raising prices, it will seek to improve its profitability by moving in on union perks and rorts. They know even Coalition-government owners give them an easier ride than a private owner would.

So voters would be mugs to believe Labor and its union mates have consumers' best interests at heart.

Unfortunately, that doesn't mean Coalition privatisers can be trusted to do their best by customers. The temptation facing all privatising governments is to seek to maximise the price they get for the asset they're selling.

If you can't see why that would be a problem, you're helping demonstrate why privatisations so often fail to deliver their promised benefits.

The main thing that protects customers from being overcharged is effective competition between the privatised entity and other businesses.

So the main way governments seek to inflate the price they get for a privatised business is to protect it from competition, or otherwise ensure its ability to overcharge. They tie the hands of the price regulator in some way, or explicitly guarantee freedom from certain future sources of competition, or sell the business to some player who already owns businesses in the industry and so can use the acquisition to increase the player's pricing power.

The simple truth that escapes so many privatisation supporters on the non-Labor side is that privatisation is only worthwhile if it leads to greater competition in the market. If it doesn't, it will be of little benefit to anyone bar the new private owners.

When the Keating government privatised Sydney airport, it guaranteed the purchaser first refusal on control of any second Sydney airport, thus virtually ensuring that even with two airports there'd be no competition between them.

When the Kennett government privatised Victoria's electricity industry in the 1990s it took care to ensure a wide range of buyers.

But it seems the Baird government in NSW has no such scruples. It planned to sell Macquarie Generation, the state's largest power producer, to AGL, one of the state's three largest power retailers.

The Australian Competition and Consumer Commission tried to block the deal, judging it would have resulted in a substantial lessening of competition in the electricity market. But last week the commission was overruled by the Competition Tribunal, so the deal is likely to go ahead.

Only a couple of days earlier, however, the chairman of the commission, Rod Sims, reiterated his view that "electricity companies have a strong commercial incentive to have all players vertically integrated ... If electricity retailers can tie up most of the generation then they can create a stable oligopoly with high entry barriers and so higher prices and better returns."

I'd be wary of believing any politician who tried telling you electricity privatisation won't lead to higher prices.

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Mike Baird's high-risk election strategy

Mike Baird is nothing if not game. His first budget as Premier is a model of fiscal rectitude - which wins him high marks from people like me, but makes this a most unusual budget for a politician facing an election early next year he can no longer be certain of winning easily.

The budget offers little in the way of tax breaks and few new spending initiatives, save for more money on child protection, disability services and homelessness.

Hardly a standard way to buy votes. The cynical may see this as the reversal of earlier budget cuts that led to political embarrassment, but I think I see signs of a more tender conscience - another rare commodity in politics.

A fourth budget of tight control on spending and steadfast revenue-raising cements the new Treasurer Andrew Constance's claim to have got the budget back on track and heading steadily into the land of surplus. If voters are looking for good managers of the state's finances, this lot is the best we've seen in a long time.

Of course, Baird is promising to spend big on a new hospital, highway or rail link near you. That's sounding more like pre-election vote gathering. But even here he's not planning to do anything that could possibly endanger the state's much-prized AAA credit rating.

As his opponents will lose no time in reminding anyone who has forgotten, almost all the goodies he's promising are dependent on him raising the money by partially privatising the state's electricity distribution businesses - a proposal the electorate has so far found utterly unattractive.

It's also a proposal that caused bitter division within the previous Labor government. It led to the demise of a premier and a treasurer, and was ultimately the greatest single contributor to Labor's ignominious defeat in 2011.

The election next March is shaping as a referendum on electricity privatisation which Labor, freed from the obligations of office, will vehemently and gleefully oppose with blood-curdling predictions about how power prices would rise.

This time, however, Baird has upped the stakes by giving all of us something to lose in the way of improved infrastructure. If you want all those goodies you have to vote for him, not the other lot. But if we vote him back, the privatisation comes too. He's nothing if not game.

It would be nice to say Baird's budgetary virtue had been rewarded by a much-improved outlook for the NSW economy. But state budgets don't have much influence over state economies.

Sometimes, however, the virtuous can have good luck. And Baird's luck is looking fine. With the mining investment boom ending, there has been a changing of the guard between the states. As Western Australia falls back, NSW takes the lead.

The whole of federal macro-economic policy is directed at encouraging growth in the non-mining economy and the non-boom states, making NSW a prime beneficiary.

The Reserve Bank is holding interest rates exceptionally low to encourage borrowing and spending, particularly on housing, and NSW is Exhibit A to show it's working. Baird's budget is getting its cut, with collections from the tax on property conveyancing now very high.

After a long period of below-average growth, the NSW economy is already growing faster than the national average and this seems likely to continue for at least another few years. That means better growth in employment and lower unemployment. Not a bad time to have an election.

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Botched reform causes higher power prices

There's no subject more likely to stir people up than rising electricity bills. With prices roughly doubling since 2007, that's hardly surprising. But why have prices risen so fast? And will they keep rising?

It has suited various business lobbies and Coalition politicians - federal and state - to leave people with the impression the main reason is the carbon tax and the renewable energy target, which requires that 20 per cent of Australia's electricity come from renewable energy sources by 2020.

In truth, the price rises started well before these measures took effect and they explain only a small part of the increase. Which suggests the politicians will suffer yet another loss of credibility when eventually (and stupidly) the carbon tax is abolished and the renewables target is dropped, as seems on the cards, but power prices don't seem to fall by much.

The more important reasons were given by Professor Ross Garnaut, of the University of Melbourne, in a recent speech. Here's my version of his explanation.

One part of the reason is that more people have been using renewable energy and this reduced their demand for conventional electricity from the grid, which is produced mainly by coal-fired generators, of course.

Apart from all the wind turbines, governments - federal and state, Coalition and Labor - have offered incentives to people to incur the significant expense of installing rooftop solar power systems.

The most generous of these incentive schemes have been abandoned but, at the same time, the cost of photovoltaic systems has been falling rapidly, partly because of advances in technology, partly because more purchasers mean greater economies of scale.

The most important economic characteristic of renewable energy is that once you've incurred the high "fixed cost" of installing a system, the "variable cost" of using the system to produce more energy is negligible. Sunshine is free. So once you've got a system, you use it.

A second important part of the reason for rising power prices is that many businesses and households have reacted to the rising price by being more economical - less wasteful - in their use of electricity.

Another factor (one many economists tend to ignore) is that all the talk about the need to reduce emissions of carbon dioxide to stop climate change, and all the talk about how much power we waste, has made more firms and householders waste-conscious. Some people are being careful in their use of electricity as a self-interested response to its rising price, while others - including businesses - are doing it from a sense of duty to society.

By now, I trust, a big red light is flashing in your head. If people are using less power from the grid because more of them are collecting their own and more are reducing their wastage of electricity, doesn't that mean demand for conventional power is falling?

Indeed it does. According to figures from the Grattan Institute, since late 2009 electricity demand in eastern Australia has fallen by about 7 per cent.

But hang on, is this guy saying the price of electricity has gone up because demand for it has gone down? Isn't it supposed to be the other way round? Isn't a fall in demand supposed to lead to a fall in the price?

Well, assuming no change in supply, yes it is. So you're right to be to be puzzled. The relationship I've described between price and demand is, as an economist would say, "perverse".

But why? Because, as Garnaut explains, we've stuffed up the deregulation of the electricity market. (Moral: as we're being reminded by the plan to "deregulate" university fees, if you deregulate or privatise without knowing what you're doing you can make things worse rather than better.)

Before the reform process began, each state had its own, government-owned electricity monopoly, with little trade between the states. From the late 1980s it was decided to break the integrated state monopolies into their component parts - generation, transmission, distribution and retailing - and form one big eastern Australian electricity market with as much competition and as little monopoly as possible.

The power stations were separated into individual businesses - some of which were privatised, particularly in Victoria - and made to compete in a highly sophisticated "national" wholesale market for electricity. Garnaut says this has worked well, with competition keeping the wholesale price low in response to the reduced demand.

But transmission (high-voltage power lines) and distribution (local poles and wires to the premises) are natural monopolies. That is, it's not economic to have more than one network. So whether these businesses are publicly or privately owned, the prices they charge have to be regulated to prevent them overcharging.

Trouble is, Garnaut says, we've done this by fixing the maximum rate of return the businesses are allowed to earn on the capital they have invested. Economists have known for 60 years that this always causes problems because it's so hard to pick the right rate of return.

If it's too low it leads to underinvestment in the physical network, causing blackouts. If it's too high, however, it leads to overinvestment in the network at the expense of business and household customers.

But as well, when monopoly businesses that are guaranteed a certain rate of return suffer a loss of demand, the regulator has to allow them to restore their profitability by raising their prices.

Another red light flashing? Surely if you keep responding to a fall in demand by raising prices, this will lead to a further fall in demand (particularly as the cost of renewable energy keeps falling) and the whole thing will keep going round and round and getting worse and worse.

Just so. People in the know call it a "death spiral". One day soon the regulators of the regulators - aka federal and state governments - will have to step in and call the madness to a halt. Until then, prices will keep rising.

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Compulsory super without protections is a rip off

A few weeks ago, when I offered my list of our top 10 economic reforms of the past 40 years, I was surprised by the number of people arguing I should have included compulsory employee superannuation in the list. Really? I can't agree.

It is, after all, merely a way of compelling people to save for their retirement. That's probably no bad thing in principle, countering our all too human tendency to worry excessively about the here and now and too little about adequate provision for our old age.

But compulsory saving hardly counts as a major reform. I suspect some of my correspondents see it as a boon for workers because it extracts a benefit from employers over and above the wages they're paid.

If so, they've been misled by appearances. Economists are in no doubt it all comes out in the wash: that when the government obliges employers to contribute to workers' retirement savings, the employers eventually make up for it by granting smaller wage rises than they otherwise would have.

It's true that compulsory super contributions - and the subsequent earnings on them - attract tax concessions, being taxed at a flat rate of just 15 cents in the dollar. But while upper income-earners do disgracefully well out of these concessions, people on incomes around the average gain little advantage, and those earning less than $37,000 a year gain nothing. Hardly sounds fair to me.

My other reservation about compulsory super is the way it compels employees to become the victims of the most shamelessly grasping, overpaid industry of them all: financial services. These are the people who made top executives and medical specialists feel they were underpaid.

Compulsory super delivers a huge captive market for the providers of investment services to make an easy living from and for the less scrupulous among them to prey upon. The pot of money the government compels us to give these people to manage on our behalf has now reached $1.6 trillion.

Most of us have little idea how much these people appropriate from our life savings each year to reward themselves for the services we're compelled to let them provide to us - and little desire to find out.

We should be less complacent. For many workers it's more than we pay for electricity each year. Think of it: we put so much energy and passion into carrying on about the rising price of power - and Tony Abbott used our resentment to get himself elected - while the men in flash suits dip into our savings without most of us knowing or caring.

To be fair, industry super funds dip into our savings far more sparingly than the profit-driven "retail" funds backed by the big banks, insurance companies and firms of actuaries. Since most workers do have a choice, you'd need a very good reason not to have your money with an industry fund.

But even this worries me. It means the union movement - the people whose job is to protect workers by being full bottle on the tricks the finance industry gets up to - has divided loyalties. Those who should be holding the industry to account are also part of it.

For years the industry campaigned for an increase in the super levy of 9 per cent of salary, arguing it was insufficient to provide people with an adequate income in retirement. This is a dubious argument, rejected by the Henry taxation review.

But look at it another way: here is a hugely profitable industry arguing the government should increase the proportion of all employees' wages diverted to the industry for it to take annual bites out of before giving us access to our money at age 60 or later.

This is classic rent-seeking. The Howard government was never tempted to yield, but as part of the Labor government's mining-tax reform package, it agreed to boost compulsory super contributions to 12 per cent by 2019. Why? I don't doubt Labor was got at by the union end of the financial services industry.

Contributions increased to 9.25 per cent last July, but the Abbott government came to power promising to defer the phase-up for two years. I'd lay a small bet this deferral will become permanent - though probably not before contributions rise to 9.5 per cent on July 1.

I wouldn't be sorry to see the phase-up abandoned. The Henry report recommended against it, arguing that action to reduce the industry's fees could produce a similar increase in ultimate super payouts. And it's doubtful that low income earners are better off being compelled to save rather than spend their meagre earnings.

The government's policy of compelling workers to hand so much of their wages over to the finance industry surely leaves the government with a greater-than-normal obligation to ensure the industry doesn't exploit this monopoly by misadvising and overcharging its often uninformed customers.

This - along with the millions lost by investors in Storm Financial and other dodgy outfits - prompted Labor's Future of Financial Advice reforms, which focused on prohibiting or highlighting hidden commissions and requiring advisers to put their clients' interests ahead of their own.

But now Senator Arthur Sinodinos is seeking to water down these consumer protections in the name of reducing "red tape". The financial fat cats live to rip us off another day.

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How six states became one economy

It's been a year of anniversaries: 50 years since The Australian Financial Review became a daily, 30 years since the floating of the dollar, 21 years since the Council of Australian Governments replaced the special premiers' conference and 15 years since the start of the national electricity market.

In the Fin Review's self-congratulatory anniversary edition - apparently, the paper brought about micro-economic reform single-handedly - one of my old bosses, Vic Carroll, made a point most of us have forgotten, if we ever knew.

Before Paul Keating began opening Australia to the world in the 1980s, we first needed to break down the barriers between the six states to get one national market. In theory we've had a common market since Federation; in practice it didn't start until the 1960s.

We had separate stock exchanges and even big companies tended to stick to their own state. Coles and Woolworths didn't start to invade each other's home states until the 1960s. The big banks were concentrated in their home states until eight merged to become four in the early 1980s.

For many years the brewers defined much of the Riverina as part of Victoria and thus out of bounds to Sydney-based Tooth and Co. It took the Trade Practices Act of 1974 to make agreements on competition-reducing territorial carve-ups illegal.

A main role of COAG has been to gain agreement between the states to align their regulation of markets and in other ways facilitate cross-border trade. Progress has been painfully slow and at Friday's meeting it gave up trying to introduce a national occupational licensing scheme.

But that makes COAG's initiative of establishing a national electricity market (covering all states bar WA) in 1998 the more remarkable. Before then, we had six separate, state-owned vertically integrated monopolies.

The Australian Energy Market Commission has celebrated the national market's 15th anniversary by commissioning KPMG consultants to prepare "a case study in successful micro-economic reform". The idea was to record the insights of key players before they were carted off to retirement homes.

It took eight years of preparation before the market began. Step one was for each state to break its monopoly electricity commission into separately owned power generators and separately owned electricity retailers, leaving the transmission and distribution network ("poles and wires") as the irreducible natural monopoly.

The generators could be made to compete with each other (and probably privatised) and the retailers made to compete with each other (and privatised) by giving them equal access to the network.

The hard part was setting up the continuously trading wholesale auction market in which competing generators supply power to competing retailers. Once the state networks had been physically connected to a single grid, this was made possible by the "fungibility" of electricity. If one unit of power is identical to any other, I don't have to actually generate the power I end up selling you.

That's handy, but it makes the market, with all its derivative contracts, horrendously complex. Its smooth operation is a notable tribute to the economist's art: it's a quite artificial, geek-designed, government initiated and regulated market. T. Abbott and other sceptics please note.

The case study should prove a useful guide to would-be reformers. One tip is that this radical change was achieved through many small steps. Each state set up its own market before they merged into one after many trial simulations.

Though the federal government had no responsibility for electricity, it was deeply committed to micro reform and, since it would benefit from higher tax collections, transferred these to the states as incentive payments for reforms achieved.

No business people or economists need telling that many people find money highly motivating. Premiers more than most. But the study warns "there are risks that the incentive becomes payment maximisation rather than policy optimisation".

Likewise, establishing a competitive industry structure must take precedence over doing things to maximise the proceeds from privatisation. "Incentive payments are not a substitute for mutual commitment to policy outcomes," we're told.

Careful planning, widespread consultation and good processes are all necessary, but the study emphasises the key role of committed leaders. At the political level, reform was pushed by Bob Hawke and Nick Greiner, by Paul Keating and Jeff Kennett, then by John Howard.

But the person who deserves greatest approbation was the chairman of the National Grid Management Council, John Landels, formerly of Caltex. His strengths were he was beholden to no one, kept the board focused while letting the technocrats get on with the details, and he had pull with prime ministers and premiers. And I doubt he was doing it for the money.

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Labor first out of blocks in race to mislead

I guess you've heard the news: the Gillard government has obtained new analysis of data from the Bureau of Statistics showing that Tony Abbott's election commitments inflict brutal damage on working families, particularly those in western Sydney, increasing taxes and cutting support to families.

According to Treasurer Wayne Swan, Abbott's commitments include scrapping the tripling of the tax-free threshold, axing the new schoolkids' bonus and abolishing family payments from the household assistance package introduced in June last year.

The government tripled the tax-free threshold from $6000 to $18,200 a year from July last year, we're told, delivering tax cuts to all taxpayers earning up to $80,000 a year. Most of these people received savings of at least $300 a year, with many part-time workers receiving up to $600.

The schoolkids' bonus is worth $410 a year for primary school students and $820 a year for secondary school students to families who receive family tax benefit part A.

The household assistance package increased payments to families who receive benefit part A by up to $110 per child and by $70 per family for those receiving benefit part B. The median family income in Fairfield is $106,000. This family, with two children both in primary school, father working full-time on $86,000 a year and mother working part-time on $20,000 will be almost $1500 a year worse off, we're told. The mother will pay $600 more in tax and they will lose $820 in schoolkids' bonus and $72 in other benefits.

The median family income in Penrith is $118,000. This family, with two primary and one high school student, the father earning $70,000 and the mother on $48,000, will be $2300 a year worse off, we're told. The father will pay $250 more in tax, the mother will pay $300 more, and they'll lose $1640 in schoolkids' bonus and $108 in other benefits.

Terrible, eh? There's just one small problem. This stuff is so misleading as to be quite dishonest.

For a start, this is just politically inspired figuring, which doesn't deserve the aura of authority the government has sought to give it by having it released by the Treasurer with a reference to "new analysis of Bureau of Statistics data" and allowing the media to refer to it as "modelling".

It's true you'd have to look up the bureau's census figures to get the details of the median family in a particular suburb, but after that the "modelling" could be done on the back of an envelope.

There's a key omission from Labor's description of its wonderfully generous household assistance package: why it was necessary. Its purpose was to compensate low and middle-income families for the cost of the carbon tax. Since the Coalition promises to abolish the carbon tax, Abbott has said that all the compensation for the tax will also go. (Strictly speaking, the schoolkids' bonus is linked to the mining tax, but the Coalition is also promising to abolish this tax, and Abbott has said the bonus, too, will go.)

The trick is that Abbott has yet to give any details of how or when these concessions would go and what they'd be replaced with. But this hasn't inhibited Labor. It has happily assumed what the Coalition intends and is presenting its assumptions as hard facts.

The most glaring omission from Labor's calculation of the hip-pocket effect of all this is its failure to acknowledge the saving households would make from the abolition of the carbon tax.

Based on Treasury's original calculations, this should be worth about $515 a year per household, including $172 a year from lower electricity prices and $78 a year from lower gas prices.

Some Labor supporters argue that even if the carbon tax is abolished, prices won't fall. This is highly unlikely. The state government tribunals that regulate electricity and gas prices would insist on it. And a Coalition government would no doubt instruct the Australian Competition and Consumer Commission to police the wider price decrease.

Labor's repeated claim to have tripled the tax-free threshold from $6000 to $18,200 a year has always been literally true, but highly misleading. That's because it conveniently ignores the complex operation of the low-income tax offset.

When you allow for this offset, which Labor has reduced and changed without removing, the effective tax-free threshold has increased by a much smaller $4500-odd from $16,000 to $20,542. This explains why the tax cut arising from the seemingly huge increase in the threshold is so modest (for many, $5.80 a week) and also why the move yields no saving to anyone earning more than $80,000 a year. For them, the threshold increase has been "clawed back".

The idea of a Coalition government bringing about an actual increase in income tax is hard to imagine. Labor omits to mention Abbott has promised a modest tax cut, though he hasn't said when it would happen.

Labor also omits to mention that the generous schoolkids' bonus replaced its earlier 50 per cent education tax refund, which offered savings of up to almost $400 a year on the eligible expenses of primary school students and up to almost $800 for secondary students.

Labor has assumed that Abbott would merely abolish the schoolkids' bonus without reinstating the education tax refund. Maybe he would; maybe he wouldn't - he hasn't yet said. But only a one-eyed Labor supporter would trust Labor to read Abbott's mind.

It didn't take the announcement of an election date to ensure the informal election campaign would begin as soon as we were back at work in January. It's a daunting thought.

But at least it gives people like me plenty of time to demonstrate the dishonesty of the claims being made.

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Smarter pricing would improve productivity

The debate over our seemingly weak productivity performance has come full circle, reverting to the explanation the big end of town was happy to accept under John Howard: almost all the weakness is explained by the special circumstances of the mining and utilities industries, which are nothing to worry about.

According to estimates by Reserve Bank researchers, after you exclude mining and utilities, labour productivity in the market sector improved at annual rates of 1.8 per cent over the 20 years to 1994, 3.1 per cent over the 10 years to 2004, and 1.7 per cent over the seven years to 2011.

However, Labour productivity in mining fell by 6.3 per cent a year over the past seven years because much higher prices justified the exploitation of harder-to-get-at deposits and because of spending on new mines that have yet to start producing.

Productivity in utilities (electricity, gas and water) fell by 5.5 per cent a year over the period, mainly because additional investment to improve the reliability of supply in the electricity and water industries has done little to increase output.

Note that a deterioration in our productivity performance isn't always a bad thing. Improved productivity is a means to an end, not an end in itself. The end is a higher material standard of living, and improved productivity is just one way for us to get richer. Another is for higher world prices to make uneconomic mineral deposits profitable to exploit. How could that be a bad thing, even if it does wreck our productivity figures?

And avoiding power blackouts and extreme water shortages is surely part and parcel of enjoying a high material living standard. If that requires us to invest in more power stations and higher-capacity power lines to cope with peak electricity demand - or requires us to build desalination plants to ensure we don't run out of water during severe droughts - what of it? Would it be better to go without to keep our figures looking good?

That's pretty obvious. But Dr Richard Tooth, of Sapere Research Group, and Professor Quentin Grafton, a water economist at the Australian National University, have separately advanced a more sophisticated argument: we could have avoided the expense of all that extra utilities investment had we been smarter in the way we set the prices of those commodities.

Starting with electricity, it has long been the case that we've needed to invest in sufficient generating and distribution capacity to cope with occasional peaks in demand that far exceed the average level of demand. These days, the peak comes on hot summer days. As household aircon has become cheaper and more ubiquitous, the peaks have shot ever higher than average demand, which is actually declining a little.

It costs a fortune to install the extra capacity - particularly the power-cable capacity - needed to ensure a lot of people turning on their aircon just a few days a year doesn't lead to the thing every state government dreads: blackouts.

But all this capital spending - and the political pain of 18 per cent increases in power bills - could have been avoided had state governments got on with installing smart meters in homes. This would have allowed prices that vary with the time of day. Significantly higher prices at the time of year when people are tempted to put on their airconditioner would prompt many to think twice. It would also be easy to encourage big industrial users to reduce their demand for relatively brief periods when household aircon was full blast.

The case of water is more complicated. Water bills are composed of a fixed charge plus a usage charge that varies with how much water you use. In (simple) theory, the usage charge should reflect the long-run marginal cost of an extra unit of water. The fixed charge is whatever additional amount is needed to cover the water company's full costs (including a reasonable return on capital).

However, the usage charge is usually too low to have much effect on consumption behaviour. And the simple theory doesn't apply well to commodities that have to be stored rather than produced to order, such as water.

As usual, in the last drought we relied on water restrictions, but they weren't sufficient to fix the problem (you can only police the water use that can be seen from the street, which means restrictions don't work well with business users) and we ended up building desal plants, only to mothball them when the drought broke.

The economists' study of the price elasticity of demand for water leads them to argue that, had user charges been raised high enough, supply could have been better conserved and desalination avoided.

User charges could have been increased to the point where they raised more revenue than was needed, thus allowing the fixed charge to be a subtraction from the total user charge. Dr Tooth argues such an arrangement would have been fairer in its treatment of low-income users.

If all those jumping on the productivity bandwagon were more genuine in their concern to raise efficiency, they would have a lot more to say about efficient pricing.

The most bizarre (and pathetic) political statement of last week was Wayne Swan's response to news the annual inflation rate had fallen to 1.2 per cent, the lowest in 13 years: "While the moderation in ... inflation is certainly welcome, many households continue to face cost of living pressures." And these guys wonder why they're not getting the appreciation they deserve.

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