Risk Management and Industrial Organisation in the Australian National Electricity Market

Abstract

The electricity supply industry (ESI) is a highly capital intensive industry, with large sunk capital investment at the upstream side. This characteristic, together with the necessity of the electric energy for the common people’s life, determined the worldwide ESI structure as government-owned vertically integrated monopolies up to the 1990s. The inefficient and suboptimal investments in the generation capacity during the 1980s inflated consumer prices to inefficient levels. This became the main reason for the governments in many developed countries to reform the industry. The Australian ESI was one of the most successful cases globally. The state-owned utilities were unbundled into four functional sectors (generation, transmission, distribution and retailing). Generation and retailing were restructured to ensure there were several competing firms, the majority of which were private. A competitive wholesale trading market for electricity – the National Electricity Market (NEM) – has been established, commencing its operations on 13 December 19981. Despite the reform, wholesale and retail electricity markets in Australia remain highly regulated. Specifically, the policymakers artificially cap both the wholesale prices and the small customer tariffs. These regulations are expected to promote stable wholesale markets and low retail prices. Over the past 23 years, however, the market has changed dramatically and gradually deviated from the origins of the blue-print market design. A vertical re-integration between the non-monopoly segments of generation and retail supply were able to raise their share in the NEM, which resulted in highly concentrated market, albeit across state boundaries. Most neoclassical economists do not support vertical integration due to the economic inefficiencies that come from the market power of large market players. The thesis attempts and tries to provide explanations for the growing trend of vertical integration in the NEM using finance arguments.