Energy Information Administration
Introduction
The
Characteristics of Individual Country Reforms
The
Characteristics of Investing Companies
Over the past few years, several nations have initiated electricity industry reform and privatization efforts. Argentina, Australia, and the United Kingdom (UK) are among those countries at the forefront of such efforts. 1 Reforms undertaken in these three countries are especially important because they have in many ways become models for reforms carried out elsewhere. From the perspective of the United States (and other countries considering electricity reform), these three nations are often viewed as laboratories in which the efficacy of particular electricity reform policy choices are geing tested. For this reason, we have referred to these reforms as "experiments." In reality, however, these reforms represent firm policy measures adopted by the countries involved.
This report reviews and analyzes the recent electricity reforms in these countries in an attempt to better understand how different models of privatization and reform have worked in practice. (For a more general discussion of some of the factors underlying the recent worldwide trend toward industry privatization, see the box entitled "Why Privatize?"
This report also analyzes the motivations of the U.S. companies who have invested in the electricity industries of Argentina, Australia, and the UK. These countries have become the largest targets of U.S. foreign investment in electricity. American electricity investment in the newly-privatized electricity industries of Australia and the UK far exceeds all other U.S. electricity investment abroad. Companies from the United States were also the largest investors in Argentina's recently-privatized electric utility industry.
This report utilized two calculations of foreign investment. One is the foreign direct investment series produced by the U.S. Department of Commerce. The other is based on transactions (compiled from the financial press) in Argentine, Australian, and U.K. electric utilities.
The electricity reform and privatization experiences reviewed in this report may offer some insight as to how the U.S. electricity industry might develop as a result of recent domestic reform efforts and deregulation at both the state and national levels.
To a large extent, Argentina's and Australia's electricity reforms were guided by reforms undertaken earlier by other countries: Australia benefitted from the United Kingdom reform efforts, and Argentina benefitted from the UK, and from Chile's reform initiatives. However, the particular electricity reforms in the three case-study countries were also guided by each country's unique governmental structures and institutions, and by such characteristics as demographics, economic and political environments, and resource availability. These factors are discussed briefly below and in more detail in the chapters devoted to each of these countries.
A unitary, centralized form of government exists in the United Kingdom. Governmental authority originates in the crown. At the time that the United Kingdom embarked upon electricity reform, all policy decisions were made at the national level. Electricity reform in the United Kingdom was therefore carried out entirely by the ruling (conservative) political party, which placed a strong emphasis on aggressively privatizing electricity-as well as several other major industries.
In contrast, both Argentina and Australia have a federalist form of government (similar to that in the United States) which is more oriented to regional, or state authority. 2 In contrast to the United Kingdom (but, again, very similar to reform efforts in the United States), electricity reform efforts in Argentina and Australia have had both a national and a state component.
Electricity reform in Australia was initially carried out by separate state governments with different ruling political parties, resulting in significant variations among the states. For instance, reform in the state of Victoria has, in general, emphasized privatization of electricity, while corporatization 3 has been emphasized in the other states. Further, each Australian state has restructured its electricity industry to a different extent, and each state has permitted a different degree of foreign investment. As a result of the variety of state-implemented reforms, Australia's movement towards a national electricity market has been more complicated than that of the United Kingdom. 4 A national electricity pool began in May 1997, although the states initially participating were concentrated in the southeastern portion of the country.
Argentina's constitution (based upon the U.S. constitution) resulted in a federalist form of government very similar to that of the United States. However, the federal government in Argentina has been a more forceful catalyst in advancing electricity reform than the Federal government in the United States.
The form of government existing in each of these nations also determined which level of government would achieve the largest financial gains from privatization. In Australia, state governments were able to erase large deficits through the sell-off of electricity assets. In Argentina and the United Kingdom, it was the national government that took in the receipts from such sales.
A commitment to free market economics is also a relatively more recent development in Argentina than in Australia and the United Kingdom. In the latter two nations, this commitment was not only made earlier, but has generally strengthened in recent years. Argentina's former heavy state hand in the national economy (and its past industry nationalizations) continue to taint it with a reputation as a relatively high-risk investment country. Argentina's current political instability also casts doubt upon the durability of its reforms and its creditworthiness. Further, Argentina is different from Australia and the United Kingdom in that Argentina is a developing nation where past investment in electricity has been insufficient. In contrast to the situation in Australia and the United Kingdom, electricity is expected to be a growth industry in Argentina, although funding such growth may be beyond the capabilities of the domestic capital market. As a consequence, while attracting foreign investment has been a less important factor in electricity reform and privatization in Australia and the United Kingdom, it has been a high priority in Argentina.
Since the implementation of electricity reform, Australia and the United Kingdom have both experienced a surge in foreign investment in their electricity sectors. Despite its higher-risk profile, Argentina has also experienced a considerable increase in foreign investment in the electricity sector. Since 1995, U.S.-based companies have acquired eight out of twelve recently-privatized electricity distribution companies in the United Kingdom. In the aggregate, the value of these acquisitions was roughly $15 billion. In the Australian state of Victoria, all five of the recently-privatized electricity distribution companies were purchased by U.S. companies. Moreover, U.S.-based companies have purchased shares in three of five recently-privatized Victorian electricity generation companies. In Argentina, U.S. companies have also been the largest foreign investors in electricity.
For other reasons, Argentina is probably the most anomalous of the three countries. Both Australia and the United Kingdom are included among the world's industrialized (or post-industrialized) economies. In both nations, electricity is a mature industry and future growth in electricity consumption is expected to trail Gross Domestic Product growth rates. Both countries have well-established capital markets and both countries had, prior to privatization, invested ample funds in their electricity industries.
Another important distinction between the three countries concerns stranded costs. 5 In Argentina and the United Kingdom, the issue of stranded costs (mostly those related to nuclear investments) greatly complicated electricity reform. In Australia (which shunned nuclear power from the beginning), stranded costs were not an issue. Australia also had a relative advantage in that its coal industry is highly efficient by world standards. In contrast, sustaining an uneconomic coal industry became another source of stranded costs in the United Kingdom.
Different demographic and geographic characteristics have also influenced the structure of the electricity industries in Argentina, Australia, and the United Kingdom. Population density in the United Kingdom is fairly high and relatively concentrated in dispersed urban areas, a fact which more readily allows for the establishment of a national transmission grid (which the United Kingdom had even prior to its current era of electricity reform). In Australia, population density is in general sparse, with the exception of the southeastern portion of the country. As a result, the establishment of an operational Australian national grid in 1997 in its initial phase was limited geographically to the southeastern portion of the continent. Currently, only New South Wales, Victoria, South Australia, and the Australian Capital Territory are interconnected. Historically, there has been little interstate trade in electricity. Argentina is similar to Australia in that its overall population density is low, but there is a high population concentration in a relatively small area. In Argentina, one third of the nation's 13 million people reside in the Buenos Aires area. As a result, the development of an Argentine national grid has been piecemeal and is still incomplete.
In all three countries, greater economic efficiencies in electricity supply were important privatization goals. Productivity was seen as being especially important in Argentina, given that it had a particularly inefficient electricity industry. In retrospect, however, the massive reduction of the Australian and UK electricity industry workforce in recent years (which occurred at the same time as electricity production rose) indicates that the electricity industries of these countries were substantially overstaffed. Since the implementation of reform and privatization measures, electricity prices in all three countries have either declined or have lagged behind overall inflation, even though both Australian and UK electricity prices prior to privatization were within the bounds of the electricity prices of other industrialized countries. 6 The overall financial performance of the electricity industries in each of the three countries has generally improved subsequent to reform and privatization.
No country has embarked upon a more ambitious and extensive program of electricity privatization and reform than the United Kingdom. In Argentina, state-wide reform has clearly lagged reform at the national level, and the degree to which electricity assets have been privatized has not been as extensive as in the United Kingdom. In contrast, reform in Australia has been more ambitious in the state of Victoria and less ambitious in the other states and at the national level. Nonetheless, all three countries have opened their electricity industries to foreign investors. Further, in all three countries, U.S.-based electric utilities have been the most prominent among foreign investors. In particular, a handful of U.S. utilities have been especially aggressive in investing in recently-privatized electricity companies in Argentina, Australia, and the United Kingdom. In several cases, the same U.S.-based utility has invested in electric utilities in two of the three countries.
The Energy Policy Act (EPAct), passed in 1992, liberalized the rules governing U.S. utility investment in electricity assets abroad. Somewhat over 20 U.S. companies, nearly all publicly-traded electric utilities, have acquired assets in either Argentina, Australia, or the United Kingdom in recent years. However, a large majority of publicly-traded electric utilities have chosen not to invest abroad. Insights as to the motivations for foreign investments in electricity can be gained by contrasting the characteristicsof U.S. electricity companies investing abroad with other U.S. electric utilities.
The companies with electricity investments in Argentina, Australia, and the United Kingdom, through 1996, are listed in (Table 1). This group of companies was compared to the group of all other publicly-traded companies classified as electric utilities (86 in number) (Appendix A). 7
Overall, the U.S. electricity companies that have invested in foreign electricity assets in Argentina, Australia, and the United Kingdom appear to have followed a strategy of more rapid corporate growth compared to other electric utilities. Based on net fixed assets (the value on companies' balance sheets of property, plant, and equipment adjusted for depreciation), foreign investing utilities grew at a 2.7-percent annual rate from 1987 through 1992 (the year EPAct was passed), and at a 3.4- percent rate since then. 8 Other electric utilities, overall, grew at annual rates of 1.5 percent and 1.0 percent over the same periods, respectively. Unfortunately, data limitations prevent an assessment of the role of foreign investment in the growth in assets. 9
The higher growth rates of electric utilities investing abroad reflect the higher growth rates of the domestic areas they serve. Over 50 percent of the sales of the foreign investing group are based in the more rapidly growing states of the Pacific Coast and Southwest. By contrast, over 70 percent of the total sales of other electric utilities were in the slower growing Northeast and Midwest areas.
Until recently, growth in the asset base of the foreign investing group appeared to come at the expense of dividend payouts to shareholders. shows that until 1990, the share of cash flow from operations (sometimes called internal cash flow) paid out as dividends averaged less than 40 percent compared to over 45 percent for other electrical utilities overall. However, since 1991, dividend payout for both groups has declined, so that by 1996 both groups were allocating about 36 percent of cash flow to dividends.
Despite the relatively smaller dividend payout, shareholders appear to have increasingly favored the electric utilities that have invested abroad A useful measure that tends to reflect investors' views of a company's earnings prospects is the market-to-book ratio. The market-to-book ratio is the market value of a company's common shares divided by stockholders' equity. Stockholders' equity is assets minus liabilities as carried on a company's balance sheet and represents the book value of ownership in the company. As stated in a popular finance textbook, 10 "the ratio of market-to-book value ... will be a good measure of the value created by the firm for its shareholders because it equals the present value of the dollars that stockholders receive for each dollar they invest in the business." shows the market-to-book ratios for the two groups of U.S. electricity companies (those that invested abroad, and those that did not) over the 10-year period 1987 to 1996. In 1987, the year in which stock prices crashed, the market value of each of the groups was only 88 percent of book value. Since then, the difference in the market-to-book ratio between the foreign investing group and other U.S. electric utilities has widened. The percent difference increased sharply in 1992, from 6 percent in 1991 to 12 percent, and in 1995 and 1996 the difference grew to 15 percent. This latter pattern appears, at least in part, to reflect investors' heightened economic expectations for what turned out to be the companies that invested in electricity assets in Argentina, Australia, and the United Kingdom. There are at least two reasons for this view. First, the difference in profitability of the two groups generally narrowed after 1991.
Although the foreign investing group's return on equity was noticeably greater in the 1987-to-1991 period, the difference in the market-to-book ratio grew most in the 1992-to-1996 period when the difference in return on equity between them and the other U.S. electric utilities virtually disappeared. That is, investors' expectations of differences in future profitability, as reflected in the market-to-book ratios, were growing even as the differences in current profitability were shrinking. Second, although the market-to-book ratio for electric utilities in total fell somewhat after 1993, the difference between the foreign investing group and the other U.S. electric utilities was at a maximum in 1995 and 1996, the years of peak investment in electricity assets abroad, thus far.
In summary, the U.S. electricity companies investing in electricity assets made available through privatization in Argentina, Australia, and the United Kingdom have pursued a strategy of corporate growth, compared with other U.S. electric utilities overall. The foreign investing group had a history of corporate growth prior to the passage of EPAct in 1992 and have since continued to grow, at least in part, through investment abroad. 11 Although corporate growth may have reduced dividend payout to shareholders, investors overall appear to favor the strategies of the foreign investors compared with the strategies of other electric utilities.
1In an earlier Energy
Information Administration report, entitled: Privatization
and the Globalization of Energy Markets, EIA presented from a global perspective an
analysis of energy privatizations developments by country and by energy sector. This study
included a section on regional reform and privatization of electricity markets. This
current report takes a more detailed look at three countries where electricity reform and
privatization have been at the forefront of such efforts globally.
2The Commonwealth
of Australia, consists of six states and two territories.
3Corporatization,
as defined in Sally Hunt and Graham Shuttleworth's "Competition and Choice in
Electricity", as "the formal and legal move from direct government control to a
legal corporation with separate management. This may be a government-owned
corporation."
4However, an
interesting byproduct of state-based reform effort is that it has induced a form of policy
competition between states and a sort of follow-the-leader type of reform. For instance,
during the initial period of nationwide electricity reform, the most populous Australian
state, New South Wales, was opposed to fully privatizing
its electricity sector, but later eventually became resigned to do so as it became clear
that this would enhance New South Wales electricity industries' ability to compete in a
national market with privatized electricity companies.
5Stranded costs
are frequently defined as the value of unamortized investments in electricity assets that
could not be recovered in a competitive marketplace or the difference between market value
and book value of these assets.
6In all three
countries, some of the decline in electricity prices can be traced to lower fuel costs.
However, a portion of the price decline can also be attributable to the substantial
non-fuel operating cost reductions made by these industries subsequent to their reform.
7The data are
taken from filings of Form 10-K with The Securities and Exchange Commission as compiled by
Compustat, a service of Standard & Poors.
8Compustat,
Standard and Poors (1997).
9Only 6 of 20
companies separately reported domestic and foreign assets in 1996.
10Alan C.
Shapiro, Modern Corporate Finance (New York: Macmillan Publishing Company, 1990),
p. 335.
11Compustat,
Standard and Poors (1997).