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National competition policy: impact on the electricity business.



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" aticIaQ Competition Policy - firnpact on the E5ec -ucity

Mr R M Bunyon General Manager & Chief Executive Officer Pacific Power

Financial Review Conference Tuesday, 26th October, 1993 Hilton Hotel, Sydney

PACIFIC POWER

"National Competition Policy - [Impact on the EDectricIlly Business"

Let me say from the start - Pacific Power is committed to a competitive electricity market. Indeed, we have been preparing ourselves for such a market for a number of years.

Over the last five years Pacific Power has been at the cutting edge of microeconomic reform in Australia.

We have put in place a strategy of commercialisation that has seen year-on-year gains for our customers, for our shareholders, the government and the community they represent, and for the environment. These gains have surpassed those potential gains sought by the Industry Commission back in 1991.

In fact, just two weeks ago I was very proud to be able to receive for Pacific Power, the 1993 National Energy Award from the Federal Government for our energy efficiency improvements in the production of electricity.

We are well on track to achieving our vision of becoming the leader in Australia's energy market in terms of customer satisfaction, profitability and environmental performance. Indeed we aim to be the

world's leading utility by I995.

These are not mere pipedreams or wishful thinking. We will achieve them because we are becoming an organisation driven by values, not rules. Values that enable the creativity and commitment of our people to shine forth.

If there is one thing crystal clear for us about the rapidly emerging competitive market, it is simpl y that

to be continually successful you must continually improve. And you can only do that through your people working as if they were owners of their part of the business.

Preparing our Plant for the Competitive Market

We've taken the hard, commercial decisions and shut down our older, less efficient power stations. We've also taken the hard people decisions and reduced our labour force some 44% since 1988, at the same time

lifting our output per employee over 118%. We've also achieved competitive coal sourcing and closed uneconomical mines.

Over the last rive years we have made tremendous strides in improving the performance of our power stations to levels that equal the best in the world.

We have lifted their average availability from 63.9% to 88.8% with our latest 660 MW units achieving over 94%. We have made similar improvements in reliability with the average forced outage rate falling

from 22.1% to just 3.8%. These performance levels significantly exceed those of equivalent North American coal-fired power stations.

We have pioneered the development of a competitive internal electricity exchange market we call ELEX. It provides our power stations with the competitive drivers of the market place while capitalising on the sy nergism of a strong organisation.

Since July of last year our power stations have competitively bid to supply the grid with power to meet our customers' needs. We've seen demonstrated gains from ELEX and learnt a good deal about what will be needed in the competitive national market.

It was a combination of all these actions that has led to a 5.4% increase in the average thermal efficiency of our power stations. This may not sound like much but

it translates into cumulative savings of over $172 million in coal and almost 7.8 mullion tonnes of carbon dioxide emissions in the last five years. Savings have also been made in fuel oil amounting to some $52 million over the same period.

Benefits from Improved Performance

I'd like to take the opportunity at this stage to clear up certain misconceptions regarding the potential gains from industry reform. Ever since the Industry Commission published its final report into the industry in 1991, various commentators have been stating that industry reform would provide $2 billion worth of gains

to electricity customers, and some reports suggested that household electricity bills would fall by $300 per year.

The fact is that the $2.2 billion of gains identified by the Industry Commission was the change in national output ... GDP, not reductions in electricity costs, and the $300 per year was the change in household disposable income, not, the reduction in electricity bills.

What the Industry Commission did claim was that if the Australian ESI achieved international best practice levels of capital and labour productivity, cost savings of $1.2 billion could be made.

Since the beginning of Pacific Power's own reforms in 1987/88, we have improved total factor productivity by 6.6% per annum, the cumulative value of which amounts to $1.1 billion. Over this period capital productivity increased by 8.7% per annum, while labour productivity improved at 12.2% per annum.

Labour productivity improvements have made a vital contribution. However, given the structure of the industry, it will be longer term improvements in capital utilisation that will have the largest impacts in the

future.

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If the development of a national electricity market is to

result in efficiency improvements, it must bring about a more productive use of the $43 billion of assets tied up in the electricity supply industry. Reform proposals

should be assessed against the question, "will this enable inputs, particularly capital, to be more efficientl y utilised?"

Pacific Power's focus has and will continue to be on improving productivity and efficiency ..... on increasing the pie to be shared between customers and shareholders. By any indicator the rate at which the

pie is growing is significant. Considerable care however is required to discern between industry reform proposals that assist genuine productivity gains and those so called reforms that are put forward to

redistribute the shares of the pie while undermining the process that produced the gains in the first place.

Achieving World Competitive Prices Looked at another way our focus on cost reduction as a corporate imperative has seen us reduce our unit costs by over 25%.

We have particularly targeted debt reduction to ensure we are not weighed down by excessive debt servicing costs as we enter the national electricity market.

Over the last five years we reduced debt by 30% from 86.1 billion to $4.3 billion. We will continue this strategy as it also provides us the gearing capacity we need to be in a competitive position to fund future

capacity expansion around the turn of the century and to compete with the large overseas utilities. It also gives the NSW Government options for future reforms in the industry.

We have returned these savings to our shareholders in the form of dividends that have grown from $10 million in 1987/88 to $299 million last financial year. Our returns are indeed those of a private sector company,

amounting to 12.5% return on assets. In the public sector such returns are often mistakenly taken to be monopoly rents.

For the last two years we've also paid taxes equivalent to that of a private company. In 1992/93 these amounted to $260 million giving total payment to government in dividend and tax equivalents of $559 million this year.

Very importantly for our customers, over the last five years we've reduced our average price by almost 7.5%.

From July of this year we reduced it a further 6.3% in

real terms. And we won't stop there. We are committed to further significant price reductions next year. Our submission to the current Government Pricing Tribunal inquiry is for just such reductions.

This is but one way we are supporting Australia's international competitiveness.

Operating Commercially for a Competitive Environment Improving our plant to world best practice, driving

down our costs and reducing our prices have all been achieved within a sound commercial framework.

We have adopted a business unit structure based on five profit centres and a small corporate group operating as a cost centre with less than 3% of our people and that includes our marketing group. Autonomy with accountability has been devolved to

the business units operating on team principles. Communication and decision making has been dramatically improved with no more than three reporting levels between team leaders and myself.

We have introduced fee-for-service for internal transactions based on market prices, service agreements and internal billing. Indeed all our service

groups have been grouped into the one business unit that must contract their services to the four operating business units and corporate. Over time they must also compete with external market providers.

Our assets are now valued on a replacement cost basis to reflect their true worth. This is particularly important in terms of determining network service charges for our grid assets.

In short, we have established sound commercial practices expected of any company operating in a competitive market.

Competition & Competitive Neutrality Competition is not new to us. Our power stations compete with each other to supply the grid_ Our coal mines compete with private mines to supply our

power stations. Our service groups compete with private firms to supply services to the power stations and grid.

Pacific Power competes with multinationals in the overseas market to supply our expertise and skills in the utility business. Many of these multinationals are ver y active in increasing the size of their business,

some at the expense of businesses in Australia.

Soon the electricity industry in Australia will compete

on a national basis to supply the electricity needs of Australians. Electricity already competes with gas and oil to meet people's energy needs,

In fact it's not generally realised the extent to which the electricity industry faces competition from other energy sources as well as competing vigorously with other electricity suppliers around the world for

electricity intensive industries.

Together these two types of competition account for over 50% of the electricity market in NSW.

In short, we compete in contestable markets and support the concept of competitive neutrality. By competitive neutrality I mean that both public and private enterprises competing in the same market

should do so to the greatest extent possible on equal terms in so far as taxation, regulation and other key business factors determined by governments are concerned.

In many cases it is considered that private enterprises are disadvantaged relative to public enterprises. However differences are being systematically addressed through corporatisation which is bringing

many Government Trading Enterprises (GTE's) to full commerciality.

The other aspect of competitive neutrality which is often overlooked is the disadvantage suffered by GTE's because of their far greater public accountability.

There are strong arguments that this is quite appropriate because no broad based shareholder group exists. But it does have the potential to work against public enterprises.

It is important as we move to the national electricity market to ensure that competitive neutrality principles are applied equally to both private and public enterprises.

Technology Development & Exporting our Expertise

As a strong organisation we are able to prepare for tomorrow by using our resources to develop world competitive technologies. The big winners in all this is not only Australia and our owners and customers, but very importantly, the environment.

The fabric filters we pioneered are now fitted to over 80% of our power stations to virtually eliminate all smoke from their chimney stacks. Our water treatment, plants at our more recent inland power

stations ensure that any water that leaves the sites is at least as good as what we took in and in most cases better

We are now developing the technologies for tomorrow for a world that will demand greater efficiencies, more stringent environmental performance and greater sustainability in development and use of energy.

There's a lot of export potential in this for us and Australia_

On the supply side we are supporting the development of renewable technologies especially wind and solar. We are looking to the next generation of more efficient fossil fuel generation such as Integrated Gasification

Combined Cycle (IGCC) which has the potential to increase the amount of electricity we can generate from a tonne of coal by some 20%.

On the demand side we are working with distributors to promote the efficient use of energy. We are pioneering some innovative uses of electricity to clean-up the environment. We have well and truly moved into the energy services business through our recently formed Pacific Power Energy Services.

It is technology development that will help us sustain our competitiveness in the national electricity market for today and tomorrow. It will enable us to not just

improve our business, but also to grow our business.

Structuring for Non-Discriminatory Access As part of our evolutionary reform for this competitive market we are moving to establish a legally separate network subsidiary to provide network service to generators and customers- From July next year the

network business will be a wholly owned subsidiary of Pacific Power.

This will enable a clear and transparent operation of what most regard as a natural monopoly. Access to the network, and hence to the customer market will be available to all on a totally non-discriminatory basis.

To make this work it is essential that access rules and usage costs of the various state networks be consistent. The NGMC is working to achieve this.

It is equally important that as commercial businesses in their own right, the networks earn a return on their assets that is comparable to the risks involved for their

owners. As they are a monopoly, this return will need to be regulated.

In some ways the national electricity market parallels the arrangements in the telecommunications industry in which Telecom makes its local network available to Optus. The difference is that with

telecommunications every customer has the right to choose their supplier. In the case of electricity only

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the big players have the opportunity to competitively

source their needs with the risk that smaller customers may be disadvantaged. Furthermore in the case of electricity there are significantly more than two generators competing to supply the national market.

Risk, Return and Market Change

As with any real reform process there is a risk that there will be winners and losers. It is important that in moving into a national competitive market in electricity we ensure that all stakeholders gain in some way.

We can maicirnise the acceptance of the reforms if our fundamental goal is to expand the pie so that there are greater benefits for all to share. In doing this we must ensure that:

-those customers who are too small to participate are adequately safeguarded through regulation;

-returns to the participants are appropriate to the risks they take;

-no stakeholder, including government, is left carrying risk for which there is not appropriate return;

-the market is developed in an evolutionary way so that market imperfections can be addressed and minimised as they arise.

In achieving this we will ensure Australia's internationally competitive electricity industry remains just that. But we must be aware that the world does not stand still. We must continue to lift our game to

stay ahead of the pack. The national electricity market gives us this opportunity.

As this occurs, the market will continue to evolve and grow. It will not remain static. Undoubtedly our traditional notion of customer and supplier will

disappear. Some customers will become self generators trading their surplus through the market. Traditional generators will become customers, buying from the market when it is better to do so. They may become involved in end-use technologies especially those that are energy intensive.

Organisations like Pacific Power have evolved to meet the challenges of changing environments. We will continue to change as we seek competitive success and new market opportunities that open up.

Niche markets will evolve to meet the particular needs of customers and suppliers. These may be based on different requirements for quality of supply reliability or the types of technology used. The markets may not

be connected to the grid as we know it. In fact trade may occur between participants who are not connected in the traditional sense.

The technologies that will blur the distinction between market players include information systems, communications, electronics, renewable and advanced generation systems.

Market trading mechanisms are limited only by the imagination and creativity of participants. Our industry will borrow heavily from existing financial markets and means of exchange which are commonplace in such markets. Financial intermediaries will be expected to play an increasingly prominent role in the trading for energy services.

The residential sector and small business and commerce account for around 50% of sales in NSW yet make up 99.8% of the customer base. Market arrangements should not be allowed to disadvantage such groups by excluding them from participation in a competitive environment.

Conclusion

Pacific Power has positioned itself for the forthcoming national electricity market. The reforms we have put in place are already returning significant benefits for all our stakeholders, And we will continue to improve as the drivers of a competitive national market come into being.

As I said at the start, Pacific Power welcomes this competition. We will be a strong competitor supporting Australia's advancement and building on improvements in Australia's competitiveness. And as the market evolves and grows so will we in ways that will add value to our business and our customers.

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