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Subsidies to the Use of Natural Resources

Environmental Economics Research Paper No.2
This report was prepared by a consultant,
the National Institute of Economic an Industry Research (NIEIR),
for the Department of the Environment, Sport and Territories.
Commonwealth of Australia, 1996
ISBN 0 642 24864 8

2.4 Electricity

Electricity is produced from a range of primary energy forms in Australia, but predominantly from coal (82 per cent), natural gas (8 per cent) and hydro (about 9 per cent). At present virtually all electricity is produced by State public enterprises though this situation is changing, particularly in Victoria.

In Australia and many other countries the electricity supply industry has been characterised by large publicly owned enterprises having little or no direct competition. This industry structure came about largely due to concerns about natural monopolies, a desire to achieve social goals through electricity pricing and, originally, the inability of the private sector to raise the capital necessary to overcome the economies of scale barriers. These concerns are now much mitigated because of better understanding of the industry, changing social policies and the emergence of new electricity generating technologies. Competition among generators and distributors is now being actively encouraged, through the national competition policy reforms outlined above, through specific state reforms, for example in Victoria , and through inter-connections between Queensland, New South Wales, South Australia and possibly Tasmania. (see Note 1 below)

More work has been done on financial and environmental subsidies in this energy sub-sector than in any of the other sub-sectors. In this report environmental subsidies to electricity production are partly covered under the primary energy source from which the electricity is produced.

Financial subsidies

Until recently virtually all electricity was produced in Australia by State owned utilities. These utilities were not subject to corporate income tax and were not required to generate normal rates of return. Rates of return were low, surplus capacity was sometimes substantial (and is still significant) and overall productivity was low. In recent years, however, and particularly since 1990, these utilities have been required by most State governments to operate in much the same way as if they were private commercial enterprises. For example, to achieve “commercial” rates of return based on replacement cost of assets,and to make dividend payments and/or tax equivalent payments to their owners. This is particularly true of the larger electricity organisations: Pacific Power, the State Electricity Commission of Victoria (SECV 96 now being disaggregated and partially privatised) the Queensland electricity supply industry and the Electricity Trust of South Australia. Set out below is a review of financial performance of major electrical utilities in Australia. The review is for 1992–93, the last year in which a complete coverage is possible and trends in the 1990s can be discerned. In 1993–94 and 1994–95 considerable change took place in the electricity industry, particularly in Victoria where the SECV was in transition to a system of disaggregated entities (13 in 1995).

In 1992–93 Pacific Power generated a return on assets (valued at depreciated replacement cost) of 12.5 per cent (16.2 per cent on equity) and made dividend payments of $299 million, together with tax equivalent payments of $260 million on revenue of $3317.6 million.(see Note 2 below)

In the same year the SECV reported a return on assets (depreciated current cost at year end value) of 10.0 per cent and paid $191 million as a Public Authority Dividend on revenues (net of asset sales) of $3170.7 million(see Note 3 below). As part of the commercialisation process for State Owned Enterprises, the Victorian Government introduced a surrogate income tax, including capital gains tax, for 1993–94. The process requires payment to the Victorian Consolidated Fund of amounts determined to be equivalent to those payable if the new entities were taxed under the Income Tax Assessment Act of the Commonwealth. The State Treasurer may make modifications to the surrogate tax laws as considered appropriate by the Treasurer.For 1992–93 the Queensland electricity supply industry (see Note 4 below) (generation, transmission and distribution) reported a 9.3 per cent return on assets (9.1 per cent on equity) from revenue of $2159.9 million on operating profit of $614 million and dividends paid of $125.0 million.

The Electricity Trust of South Australia (ETSA) in 1992–93 reported a 10 per cent return on assets and paid $153.7 million to the State Government from revenues of $897.3 million.(see Note 5 below)

In the case of the State Energy Commission of Western Australia (SECWA), until 31 December 1994 gas and electricity operations were combined. Data in annual reports to the end of 1994–95 were insufficiently disaggregated to compare financial performance for electricity operations with the other major utilities. However, data from a study on the performance of government trading enterprises estimated that in 1993–94 the electricity operations of SECWA achieved a rate of return on assets of 12.6 per cent.(see Note 6 below)

The smaller electrical utilities are improving their financial performance but are generally not as advanced in this trend as the major utility organisations. For example, the ACT Electricity and Water Authority (ACTEW) accounts for 1992–93 indicated a 6.5 per cent return on electricity assets, and a negative return on water assets. Dividend payments to the ACT Government amounted to $24.5 million, from total revenue of $323.2 million.(see Note 7 below) Thus, for the smaller electricity utilities the failure to achieve an 8 per cent real rate of return may be of some significance. Assessment of the situation in the many (plus 50) smaller generating and/or distribution utilities would require comprehensive analysis beyond the resources available for this study.

Prior to 1990 investments by the State owned electrical authorities did not, in the main, generate normal rates of return. Hinchy, et al(see Note 8 below) estimated that electricity prices in 1989–90 were, on average, 28 per cent below the levels needed for utilities to earn a real rate of return of 8 per cent on capital; the effect of changes since that time has not been studied in detail but it seems that real rates of return have risen considerably over the past five years.(see Note 9 below)

While the financial performances of electrical authorities cannot be directly compared with private sector returns due to different asset valuations(see Note 10 below) and the evolving nature of the business, it is difficult to argue that the larger electricity enterprises are now producing financial returns to their state owners lower than “similar” commercial enterprises. Currently they are realising reported rates of return at or above a level which could be viewed as a subsidy and are making payments to State governments in lieu of dividends and taxes.

Community service obligations such as pensioner rebates and uniform pricing are a potential source of inefficiency in electricity pricing.(see Note 11 below) Pensioner rebates and concessions to other groups were estimated from state budget data and included in Table 8. Uniform pricing among users within the same broad enduse categories fails to take account of differences in the cost of supplying each user. Conversely, different electricity prices are often applied to different users with the same supply cost. As a group, industrial users typically pay more than the cost of supply, whereas domestic and farm consumers pay considerably less than cost,implying a cross-subsidy between these user groups. Estimates of cross-subsidies were not covered by the study’s terms of reference .

In the evolving electricity regime it is not yet clear how community service obligations and cross-subsidies will be actually treated in the future. The intention is to remove them from operation of the electricity sector and address them directly, for example by social and industrial policy, where deemed necessary. To some extent this is now occurring. In practice, however, the outcome will depend on the approach taken by regulatory authorities and the individual governments concerned.

The above discussion indicates that a variety of factors are currently involved in Australian electricity pricing. Each of these factors can cause electricity prices to diverge from real cost levels in an efficient system. Some factors suggest that electricity prices are overall too low, while the influence of other factors such as inefficient operations point towards prices being too high. A 1994 BIE report concluded that current evidence is insufficient to obtain a firm estimate of the net influence of these factors on electricity prices.(see Note 12 below) Over the medium to long term, if opportunities for efficiency gains from competition in a national grid are realised, and if production externalities are not included, the average real price of electricity could fall and thus encourage an increase in demand.

Environmental subsidies

Electricity transmission and distribution activities can give rise to aesthetic externalities (particularly in areas of tourism potential), to biodiversity impacts (in sensitive ecological areas) and to health effects from electromagnetic fields (EMF). Each of these impacts, particularly those associated with EMFs, are contentious and no attempts to value them in financial terms appear to have been made.

As indicated in the introduction to this chapter, environmental subsidies associated with different energy sources of electricity are covered under each primary energy source.

Note 1 The National Grid states.
Note 2 Pacific Power Annual Report, 1993,pp.3,11 and 41.
Note 3 SECV Annual Report, 1993, pp.21, 32 and 41, 45 and 64.
Note 4 Annual Report , Queensland Electricity Commission, 1992–93, p.40.
Note 5 Annual Report , Electricity Trust of South Australia, 1992–93.
Note 6 Government Trading Enterprises’ Performance Indicators , 1989–90 to 1993–94, Standing Committee on National Performance Monitoring of Government Trading Enterprises, April 1995 (GTE PI, 95), Summary, p.36.
Note 7 Annual Report, ACT Electricity and Water Authority, 1992–93.
Note 8 Hinchy, M.D.,Naughton, B.R.,Donaldson, P.K.,Belcher, S. and Ferguson, E. (1991), The Issue of Domestic Energy Failure, Project 4127.101, Australian Bureau of Agriculture and Resource Economics (ABARE), AGPS, Canberra.
Note 9 Different estimates of the capital base lead to different conclusions on the degree of under-pricing. While past practice among utilities has been to value their asset base according to historical costs rather than replacement cost (Hinchy et al 1991), changes to the capital base will alter rates of return under ruling prices. Write off of poor investments and the elimination of excess capacity under micro-economic reform will reduce the effective asset base of some suppliers. The losses estimated by Hinchy, et.al. reflected current rather than efficient capital stocks and made no allowance for write-off of poor investment decisions; hence the losses estimated tend to be overstated.
Note 10 Each of these entities now predominantly value their assets at current replacement costs rather than historical costs. A national committee (of COAG) has recommended use of a deprival value approach; this approach is based on the present value of prospective returns from assets.
Note 11 Industry Commission (IC), Energy generation and distribution, 1991.
Note 12 Energy labelling and standards, Bureau of Industry Economics, Research Report 57,1994, p.79.

2.5 Energy use


Energy use is usually analysed on the basis of the major end-use sectors: residential (house holds); commercial (retail offices, etc.); industrial (manufacturing, primary industries); and transport (road, air, rail, etc.).

Road transport is the energy use sector which has attracted the most attention in the analysis of financial and environmental subsidies. This sector is analysed separately in Section 2.6, Road transport below.

Improvements in energy use efficiency reduce, ceteris paribus, the magnitude of financial and environmental subsidies associated with the production, transmission and use at a given level of services provided by energy. Energy efficiency improvements can be promoted by a combination of higher energy prices and other instruments such as efficiency standards, information programs and support for R&D on energy efficient techniques. There is considerable debate on the choice of instruments to promote energy efficiency. In selecting among these instruments there is a need to consider the possible market distorting impacts of their deployment.

Financial subsidies

Financial subsidies to non-transport energy users are mainly for electricity cost concessions to low income groups. These concessions amounted to around $300 million a year in 1994 according to our survey of 1994 budget papers. These subsidies encourage inefficient use of energy, an effect which could be reduced if this subsidy were delivered through general social assistance programs. However, income elasticities of demand are low and the disturbing effect therefore small.

In 1994–95 the federal government allocated $5.6 million to the National Energy Management Program which promotes energy efficiency in the business sector and thereby reduces environmental impacts of energy systems.

Environmental subsidies

Environmental effects from the use of the various energy forms are discussed above in the sections on these energy forms.

2.6 Road transport


Road transport, which in Australia and other countries dominates transport energy use (see Table 7) and which mainly uses liquid petroleum fuels as an energy source, is a complex analytical area.

Table 7 Energy consumption in Australian transport, 1992–93 (petajoules)


Sector Energy use Percentage
Road
Cars
Trucks
Buses
Motorcycles
783.0
513.7
249.7
16.4
3.2
78.9
Air
Domestic
International
139.1
63.9
75.2
14.1
Rail 25.2 2.5
Marine
Costal
International
44.5
19.7
24.8
4.5
Total 991.8 100.0

Source: Transport Greenhouse Emissions,Bureau of Transport and Communications Economics, September 1994, p.xii.


Transport by road produces a range of external effects, including noxious emissions (oxides of nitrogen, etc.), greenhouse gas emissions (carbon dioxide, methane, etc.), disruption of landscapes and wildlife, loss of aesthetic values, noise and congestion. Of these external effects, noxious and greenhouse emissions (see Note 13 below), and to some extent noise, are regarded as environmental externalities.(see Note 14 below)

The financing of roads in Australia is undertaken mainly from general revenues of governments and includes substantial specific purpose grants from the federal government to State governments. Excise taxes on petrol and diesel fuels, which are expected to total over $9 billion in 1994–95, are widely regarded as being predominantly a crude road user charge. None of the revenues from these excise taxes are formally hypothecated to road construction and maintenance and their relationship to the costs of road provision is distant: e.g. they do not recognise urban/rural differences in cost, or differences in costs occasioned by different classes of vehicle and at different times of day.(see Note 15 below)

However, revenues from State licence fees are generally devoted to road construction. Financial subsidies to road users are discussed below.

Financial subsidies

Transport financial subsidies which encourage road energy use and associated degradation of natural resources arise when road users do not pay the full costs of road provision. Currently, road fuel excise taxes and other charges on Australian road users exceed total road construction and maintenance costs but they do not fully meet the criteria for user charges set out in Chapter 1 of this report. As a result some road users are not paying the full costs of providing parts of the road system used by them. In particular, the cost of land taken up by roads is seldom included in the costing of roads, and in the case of urban roads these costs are substantial.

Unlike other utilities, roads have not so far been treated as a capital asset which should be required to earn a rate of return. This treatment would recognise not only the capital value of bridges and road pavements, but of the land devoted to roads. The Australian Bureau of Statistics (ABS 5204.0) in its national accounts provides an estimate of the replacement value of the accumulated stock of road bridges and pavements. In 1991 the value was $44400 million. By the end of 1994 the value might have reached $50000 million in 1994 dollars, worth $4000 million a year at 8 per cent real.

Note 13 Discussed above in the sections on energy forms.
Note 14 Noise is regarded as an environmental externality by the State EPAs, and is often treated as such in environmental externality studies. Thus noise is a significant “atmospheric” environmental externality, emanating at harmful levels, from the transport (road, air, rail) and non-transport (refrigeration systems,etc.) sectors.
Note 15 The National Road Transport Commission (NRTC),has recommended and the Ministerial Council for Road Transport has agreed, that 18/litre of the 30.75/litre diesel excise should be regarded as a charge for road damage.

The theory of land valuation is that all land should be valued at opportunity cost. Applying this to road land would result in its site value being inferred from the adjacent properties. There have been no official attempts to value the land devoted to roads in Australia. However, an order of magnitude can be inferred from data collected by the Commonwealth Grants Commission. According to the Commission, the site value of rateable land in Australia in 1991 was approximately $545 billion, of which $478 billion was accounted for by commercial, industrial and residential land. Government offices and the like were not included in this total. Neither were parks or roads. However, the value of land devoted to these uses could be inferred from the adjacent sites. With roads fairly evenly distributed across residential, commercial and industrial areas, and forming (say) a 25 per cent addition to the rateable land of such areas, the site value of roads in such areas would be approximately $120 billion. Roads in rural areas may be added, but they take up a small proportion of the rural areas and so do not add much to the total site value of roads.

The estimate of 25 per cent of rateable area is obviously a ‘ball park’ figure. However, before it is rejected the following should be considered: it is only 20 per cent of rateable area plus roads, and assumes that other non-rateable land is valueless. It is certainly not true that the land under public buildings has no site value.

It may be claimed that roads have no site value because without them it would not be possible to access other sites. This is certainly not true at the margin: road extension in urban areas can be very expensive in terms of land purchase, though road authorities typically endeavour to avoid cash costs by using land already in pubic ownership. However, the site value of the roads may be capitalised into the adjacent sites, except for the site value of freeways and many main roads, which has a negative effect on adjacent sites. If this is the case, the site value of roads may be reestimated as 25 per cent (the share by area) of the site value of adjacent properties,amounting to somewhat over $96 billion, say (conservatively) $100 billion at the end of 1994. At an 8 per cent real rate of return the site value of the roads would be $8 billion a year. Add this to the capital return on the improved site (road pavement, bridges, etc.) value estimated above, and the required revenue is $12.0 billion a year plus maintenance costs estimated at $2.5 billion: total $14.5 billion. For comparison, in 1994 road users paid approximately $13.3 billion in fuel taxes and other quasi user charges to the Federal and State Governments. This gives an order of magnitude financial net subsidy of $1.2 billion.

A recent Industry Commission (IC) study reviewed a number of recent Australian studies on road costs and benefits.(see Note 16 below) This review indicated a wide range of outcomes, from a deficit (net subsidy) to a surplus, when financial subsidies were considered. The main reasons for the differing conclusions were found by the IC to be the unreliability of much data and the differing methodologies and assumptions employed. Our conclusion is, however, that there is a substantial subsidy to road users, particularly those in urban areas.

A major financial subsidy issue relating to roads and other resource areas is, that for efficient use of roads the costs of road provision, maintenance and externalities should be charged directly to specific road users. Excises and other levies which are not related to specific road uses should ideally be replaced by true user charges. Direct road pricing, which is now becoming technically feasible and available, would serve this purpose. If excises and other road user payments are not accepted as user charges the subsidy to road users rises to near the $14.5 billion in road costs estimated above.

Other policies and practices encourage the overuse of road transport, particularly low or no parking fees and the provision of cars as part of a remuneration package. To some extent the fringe benefits tax has reduced these benefits to auto users.

Note 16 Urban Transport, Industry Commission, Report No. 37, February 1994; environmental and other transport externalities were also considered in the review.

Environmental subsidies

Transport energy use can have significant environmental effects; as these effects are mainly due to the use of petroleum products they are covered in Section 2.2.3 above.

Summary of road transport subsidies

The analysis of road transport energy use, set out above and in Section 2.2.3, indicates that financial and environmental subsidies to urban road users are probably substantial. Despite recent progress, more work needs to be done in this area to extend subsidy valuations and to evaluate policy options to remove/internalise these subsidies.

2.7 Other transport modes

Although the road sub-sector dominates transport energy use (see Table 7) other subsectors are of importance, particularly air.The wider application of user pay principles in the case of aviation and marine services, and the reduction in subsidies to state owned rail services, are reducing implicit and explicit financial subsidies to these non-road modes. Some, however, remain but their estimation would require resources beyond those available for this study.

Environmental subsidies (external effects) of these modes while not as substantial as those from the road sub-sector, may be significant. Discussion of some marine transport externalities is included in this chapter in the oil section and also in the fisheries chapter. These externalities are those from shipping oil spills and release of ballast water respectively. In the air sub-sector noise and greenhouse gas emissions are significant, and in the rail sector noise, noxious and greenhouse gas emission externalities are present.

2.8 Summary

The above discussion of financial and environmental subsidies in the energy sector indicates that these remain substantial despite significant removal of subsidies over the past five years. Of particular importance are those associated with electricity production, greenhouse gas emissions and road transport.

A summary of financial and environmental subsidies for the energy sector is provided in Table 8. As indicated in discussion of the various energy areas above, the estimates of subsidies provided in Table 8 are not comprehensive.


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