3.1 Australian Experience to Date
Like the rest of the world, Australia's experience with multi-utility firms to date has also been diverse. Of the major entities operating in the water sector there are two – in the Northern Territory (Power and Water Corporation) and the Australian Capital Territory (ACTEW) – that have historically been involved in the provision of multiple utility services. The Power and Water Corporation is a publicly owned corporation and monopoly service provider of water and energy services that gives customers combined bills.15 ACTEW is a publicly owned corporation that owns the Australian Capital Territory's water and sewerage assets, and a fifty per cent interest in the ActewAGL joint venture. This joint venture between ACTEW and the privately owned AGL and Jemena comprises two partnerships – one involved in the retailing of energy, the other operating electricity and gas networks. Until 30 June 2012, it also managed the water and sewerage network on ACTEW's behalf. ActewAGL bundles a range of utility services to households and businesses (such as electricity, gas and telecommunications services), but these bundling arrangements do not include the provision of water and wastewater services.
In each of the other State jurisdictions, water and energy services are provided by entirely separate entities. There is, however, considerable diversity as to how these service providers are structured. In the water sector, providers range from a single, publicly owned, vertically and horizontally integrated entity that operates across an entire State (e.g. Western Australia's Water Corporation) to ones operating within a far more disaggregated, metropolitan-based structure (e.g. Melbourne Water, Yarra Valley Water, South East Water and City West Water in Melbourne, Victoria). Generally, there tends to be an integration of both water and wastewater services, although the approach taken is far from uniform. In Perth, Adelaide and Sydney, a single entity is responsible for the provision of these services, whereas both Melbourne and Brisbane/South East Queensland provide examples of more disaggregated approaches (Abbott & Cohen, 2010).
In the energy sector, there are many examples of privately owned, integrated providers of gas and electricity services (e.g. AGL, Energy Australia and Origin). However, these energy services providers also tend to separate out the provision of network elements (i.e. distribution and transmission services) from other aspects of energy provision.16 As the water and energy sectors are in the main structurally separate in Australia, the extent of bundling of utility services which has occurred to date in Australia has been limited and concentrated primarily in combining electricity and gas bills.
3.2 Implications for Australia
Both the literature and international experience provides guidance as to the potential for actual or virtual integration of utility service provision. Looking first to the energy sector, a range of reasons have been elicited as to why the development of combined gas and electricity utilities, and the adoption of bundled service provision, has already occurred. First, there is the potential for cost efficiencies associated with such combined service provision. As noted previously, the available evidence with respect to economies in joint production is mixed. However, there has certainly been a tendency for electricity companies to become involved in gas developments and vice versa. In part this may stem from the capacity of gas to be used both as energy source in its own right, and also as a feedstock for electricity production. In this regard, combining electricity and gas production activities is consistent with a strategy of internally hedging – a practice that more broadly manifests through the integration of generation and retail activities. Secondly, the relationship between the energy products – in particular, that as substitutes they are negative correlated in value – facilitates the adoption of a mixed bundling strategy insofar as it enables price discrimination (though conversely restricts its use as a barrier to market entry) (Nalebuff, 2004). Thirdly, firms operating within the energy sector do so within a predominantly competitive market framework (particularly in generation and retail of gas and electricity), which means that companies are not seeking to protect pre-existing monopolistic prices or returns. Combined, these factors encourage both integration and bundling.
However, the same literature suggests the development of multi-utilities in Australia incorporating both energy and water activities is a more complex issue – particularly from a broader community welfare perspective.
At first blush, a strategy of integration of water and energy services would appear viable in that the basic economic attributes in both sectors – significant sunk costs, low price elasticities, large fixed costs and low marginal costs of production – lend themselves to combined service provision and viable bundling strategies (see Papandrea et al., 2001, p. 22). There are, however, other factors that have tended to positively encourage energy and water companies to move away from each other rather than combine; that is, the water sector moving into waste and environmental management (e.g. Veolia), and energy companies to mineral resource development (e.g. AGL).
In the first instance, the economies of scope that exist between the water and energy sectors appear to be limited. It is possible there may be some efficiencies in joint production – in areas such as pipe construction and operation, hydro-electric generation from water storages, and the utilisation of the water utilities’ energy demand as a risk management tool to balance overall electricity usage, and hence generation, profiles.
However, the clearer potential benefits that could be expected to be associated with the development of multi-utility firms involving both the energy and water sector centre around efficiencies with respect to transaction costs – through mechanisms such as common billing systems, integrated call centres, combined metre reading processes and joint marketing.
Efficiencies of this type are, however, proportionally quite small in terms of the overall cost of utility service provision, and also reducing over time as technology enables innovation in these areas. In the case of electricity the proportion of costs associated with the retailing of electricity – as compared to the generation, transmission and distribution – has been estimated at around five to ten per cent of total costs (Abbott, 2002). Similarly, in the water sector, retailing only accounts for around five per cent of total costs. As such, any gains that may be made from integrating billing systems across utilities can be expected to have only limited impact on final prices, particularly once transitional costs have been incorporated and where efficiency benefits have been achieved through specialist outsourcing. Furthermore, there is also a potential risk that integrating billing systems across multiple utilities would create a greater level of complexity that may impinge on the extent to which those systems can be utilised to enhance service quality through improved customer interactions (such as responding to requests for fault rectifications).
The integration of water and energy utilities also brings with it other risks and complexities. For example, there may be some potential – at least in the short term – for the development of multi-utility firms to lower prices as firms cross-subsidise water services with revenues from energy sales (if permitted by law) so as to build market share. However, whether such an outcome would actually occur is unclear. As Schmalensee (1982) noted, such a pricing strategy is likely to be of limited benefit where it involves the monopoly provision of one product/service and competitive provision of another. In the Australian context, the still monopoly and price regulated position of the water suppliers in contrast to the more competitive markets faced by the electricity and gas retailers would act as a substantial impediment to this kind of pricing behaviour.
And even if such pricing behaviour did occur, the overall benefits are not clear cut. While lower prices would ostensibly be regarded as positive, whether such an outcome results in net community benefit is itself far from certain – particularly given the extent to which the water sector in Australia is predominantly publicly owned.
On the further question of efficiency, to the extent that cross-subsidisation from the water sector would result in lower energy prices than would be set in a purely competitive environment, this could result in energy usage being distorted. At an institutional level, it is also likely to be of concern if governments – being both regulators and owners – were able to place water utilities in an advantageous position against privately owned energy firms. The potential that publicly owned water utilities could encroach into the predominantly privately owned energy sector could be expected to act as a barrier to investment by those private sector firms. This would be particularly so given the range of economic, regulatory and policy barriers that operate to inhibit the scope for the private sector to operate in the Australian water sector, and hence prevent those entities from undertaking such integration and bundling activities.
Given such concerns, it is reasonable to suspect any move towards enabling greater integration or bundling of utility services would need to be accompanied by structural changes that enabled either greater competition in the water sector and/or scope for greater involvement by private sector utilities. However, this itself gives rise to the potential cost of the loss of monopoly control for existing owners – which in the case of the water sector in Australia are the States and Territories.
To some extent, the risks associated with price discrimination in the water and energy sectors in Australia are ameliorated by the pricing regulatory arrangements that operate across the country. However, there is a risk that both real and/or virtual bundling of utility services could make the regulation of utilities more complex, less transparent and less effective.
Notwithstanding these regulatory issues, Calzolari and Scarpa (2007) still concluded that there was benefit in permitting multi-utility firms so as to enable advantage to be taken of the integration benefits that may come from the development of multi-utility firms.17 However, such concerns give substantial weight to Chaaban (2004) suggestion that the emergence:
… of multi-utility firms requires increasingly sophisticated theoretical and practical regulatory mechanisms that could cope with and ultimately facilitate these kind of changes – particularly where combines competitive and monopolistic elements. Further, the type of regulatory model to apply may differ depending on whether full information available or information asymmetry exists between incumbent and regulator; nature of interaction between incumbent and regulator and extent of economies of scope which may exist as a result of integration (which could be lost if, for example, regulation required structural separation to occur.