the productivity and efficiency of the australian electricity supply industry

7/25/2019 The Productivity and Efficiency of the Australian Electricity Supply Industry

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The productivity and efficiency of the Australian

electricity supply industry

Malcolm Abbott

C / -P O B o x 2 9 9 5, A u ck l an d , 0 0 0 1, N e w Z e a l a nd

Received 27 September 2005; accepted 18 October 2005

Available online 19 December 2005

Abstract

Australias electricity supply industry has been through a period of reform over the last 10 years. The

purpose of this paper is to analyse the changes that have occurred to the Australian electricity supply

industry over the past 30 years, in order to evaluate to what degree these reforms have improved the

productivity and efficiency performance of the industry.

D 2005 Elsevier B.V. All rights reserved.

JEL classification: L94 Industry studies Electric utilities; Q48 Energy government policy

Keywords:Technical efficiency; Scale efficiency; Data envelopment analysis; Total factor productivity

1. Introduction

Over the past 20 years, the Australian Federal and State governments have made considerable

efforts to improve the efficiency and productivity of the electricity supply industry. Before 1991,the Australian electricity supply industry consisted of a series of state-based, government owned,

mainly vertically integrated electricity authorities. Since the 1991 publication of the Industry

Commissions (1991) report on energy generation and distribution, these entities have been

broken up into their constituent parts (generation, transmission, distribution and retail): the

majority of states linked into a national market, competition introduced into the wholesale

electricity market, and retail competition introduced for large consumers. In two states,

electricity assets have also been privatised.

The basic purpose of the restructuring and introduction of competition into the electricity

supply industry has been to promote the more efficient operation of the industry, which in turn

0140-9883/$ - see front matterD 2005 Elsevier B.V. All rights reserved.

doi:10.1016/j.eneco.2005.10.007

E-mail address: [email protected].

Energy Economics 28 (2006) 444454

www.elsevier.com/locate/eneco
http://dx.doi.org/10.1016/j.eneco.2005.10.007http://dx.doi.org/10.1016/j.eneco.2005.10.007http://dx.doi.org/10.1016/j.eneco.2005.10.007mailto:[email protected]


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will lead to lower prices for electricity. The purpose of this paper is to use the data

envelopment analysis (DEA) Malmquist approach to estimate total factor productivity (TFP) of

the electricity supply industry, broken down into its state-based constituent parts over the long

term (1969 to 1999). By looking at the long-term changes in productivity levels, it will bepossible to get a more realistic view of the degree of change that has occurred to electricity

industry productivity and efficiency that has been brought about by the restructuring that

occurred during the 1990s. The paper is outlined as follows. In the Section 2, a description of

the broad structure of the industry over the past 30 years is presented. Past studies are reviewed,

the data employed and the estimation methodology are outlined in Section 3. The results are

analysed inSection 4 and some conclusions are made inSection 5.

2. Industry structure

Between 1969 and 1990, the Australian electricity supply industry was dominated in eachstate by a single vertically integrated State government-owned authority or a collection of State

government-owned authorities. These bodies were also responsible for regulating electrical

safety of the industry in such areas. Under these arrangements, investment in the new

generation was largely the responsibility of State governments and their electricity authorities.

Electricity prices were set by the State governments and were designed to cover the industrys

costs, plus any return required by them as owners. Often politically motivated cross-subsidies

were built into price structures. The six main electricity supply companies for the six states

were, respectively, the Electricity Commission of New South Wales, the State Electricity

Commission of Victoria, the Queensland Electricity Commission, the Electricity Trust of South

Australia, the State Energy Commission of Western Australia (included gas as well aselectricity), and the Hydro-Electric Commission of Tasmania. With the exception of the States

of New South Wales and Queensland, each company run a vertically integrated operation

including generation, transmission and distribution of electricity. In New South Wales and

Queensland, distribution was carried out by a series of local power boards. Moreover, the

Federal Government operated the Snowy Mountains Hydro-Electric Authority as a purely

generation company.

After 1991, State governments began working to restructure their electricity authorities,

although the pace of this reform has varied across the different States.1 The first state to

introduce a wholesale electricity market was Victoria, which opened the Victorian Power

Exchange in 1994. This was followed in 1996 when Transgrid began operating the New SouthWales wholesale electricity market. These two major markets were subsequently joined and, in

1998, the National Electricity Market (NEM) commenced. The NEM is a wholesale market for

the supply and purchase of electricity, combined with an open access regime for use of

transmission and distribution networks in the participating jurisdictions of the Australian

Capital Territory, New South Wales, Queensland, South Australia and Victoria. Two

companies, the National Electricity Code Administrator Limited (NECA) and the National

Electricity Market Management Company Limited (NEMMCO), were formed in March 1996

by the participating jurisdictions to implement the NEM. NECA supervises, administers and

1 This process was initiated in May 1991 when the Industry Commission delivered its report entitled Energy generation

and distribution which recommended a major restructure of the electricity industry by disaggregating existing utilities

into generation, transmission and distribution components. It also recommended that each element be corporatised and a

competitive market established.

M. Abbott / Energy Economics 28 (2006) 444454 445


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enforces an industry code of conduct and NEMMCO manages the wholesale electricity market

in accordance with the code. NEMMCO is responsible for the day to day management of thepower system.

As well as establishing a wholesale market for electricity, the vertically integrated electricity

companies were broken up into constituent parts and corporatised, and, in the Victorian and

South Australian cases, privatised. In each case, the basic division of the electricity authorities

was into the four distinct components: competitive elements (generation and retailing) and

monopoly elements (high voltage transmission lines and lower voltage local distribution).2 The

basic purpose of this separation has been to foster competition between generators of electricity

while leaving the monopoly transmission and distribution elements regulated. In each of the

NEM States (New South Wales, Victoria, Queensland and South Australia) generation was not

just separated from transmission and distribution but was also broken up into competinggenerator companies. At the other end of the electricity chain, retail competition has been

introduced in each of the NEM states for large consumers in the late 1990s and is scheduled to

be progressively introduced in each state for all users in the years 2002 to 2004.

3. Productivity and efficiency measures

In determining the performance of a firm or industry a range of indicators can be used. The

conventional indicators of performance include such things as the level of rates of return and

prices. InFig. 1, the rate of return for the Australian electricity supply industry is given for the

2 This model has occurred in all states except in Western Australia, which is outside the NEM and where a vertically

integrated government-owned company has been maintained, although gas supply was separated from this organisation

in 1994/1995.

0

1

2

3

4

5

6

7

8

%

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

Source: Electricity Supply Association of Australia

Fig. 1. Rate of return of the Australian electricity industry (earnings before interest and tax/total assets).

M. Abbott / Energy Economics 28 (2006) 444454446


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period 1969 to 1996 (earnings before interest and tax/total assets). FromFig. 1, itcan be seen

that the rates of return for the industry were quite modest in the 1970s but improved in the late

1980s and early 1990s. Another indicator of the industrys performance is the level of prices of

electricity. Fig. 2 gives an index of the average price of electricity (revenue from electricitysales/electricity generated and sold) over the period 1969 to 1999. As can be seen in Fig. 2, the

average real retail electricity price declined through the early 1970s and 1990s but rose during

the 1980s. These two indicators would suggest that the electricity industry improved its

performance over the longer term and passed on some of these improvements to final

customers.

Utilities such as electricity supply, however, often operate in markets, which lack prices and

costs determined under competitive conditions. This was certainly the case for the electricity

supply industry before the reforms of the 1990s and this still exists for important components of

the industry such as distribution and transmission. In cases such as these, the usual market

indicators of performance, such as profitability and rates of return, cannot be used to gauge anindustrys economic performance accurately. It is possible that these financial indicators will be

more an indication of the distortions themselves rather than of the performance of the industry in

question. In these circumstances, indicators of the level and change of productivity and

efficiency are more appropriate indicator of an industrys performance.

Efficiency can be defined as being the degree to which resources are being used in an optimal

fashion to produce outputs of a given quantity. There are three main aspects of economic

efficiency: technical, allocative and scale (Farrell, 1957). Productivity on the other hand is a

measure of the physical output produced from the use of a given quantity of inputs. In the past,

the common method of determining levels of productivity and efficiency for the Australian

electricity supply industry has been to construct index numbers that indicate partial factorproductivities. For example, million kW h produced or sold per employee is a labour-based

partial productivity measure (seeFig. 3). In the electricity supply industry, capital productivity

measures are difficult to calculate given the difficulty in measuring capital inputs. Three

0

20

40

60

80

100

120

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

Source: Electricity Supply Association of Australia. Australian Bureau of Statistics.

$perMW

Fig. 2. Average real revenue for electricity sold in 1989/1989 $.



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commonly used indicators of generation capital utilisation, and therefore capital productivity, arethe load factor, the capacity factor and the reserve plant margin, respectively.3 The capacity

factor of the Australian electricity industry is given in Fig. 4. Further examples of labour

productivity and capital productivity measures can be found in the Bureau of Industry

Economics I n t e r n a t i o n al b e n c h ma r k i n g 1 9 9 6 .

Although relatively easy to calculate the partial factor approach has a disadvantage in that it

can be misleading when looking at the change in productivity of an industry. If the process has

simply involved a substitution of capital for labour, then a TFP indicator that indicates a more

modest increase in overall productivity would be a more appropriate measurement of

productivity. A TFP index is the ratio of a total aggregate output index to a total aggregate

input index. Examples of this approach in the Australian case include the work conducted byLawrence, Swan and Zeitsch (Swan Consultants, 1991) and the Industries Assistance

Commission (1989). The method used in this study was a multilateral one, which compares

the performance of different firms over time. This study included one output (GW h of electricity

supplied) and four inputs: capital stock (calculated using the perpetual inventory method), labour

(persons employed), fuel (TJ) and other materials and services. During the 1990s, the Steering

Committee on National Performance Monitoring of Government Trading Enterprises used the

same method for calculating the TFP of the various government-owned electricity companies

operating in Australia (Steering Committee, 1992, 1998). Coelli (1996a) in another study

measured the technical efficiency of coal fired electricity generators in Australia between 1981/

82 and 1990/91.

0

1

2

3

4

5

6

millionKWhoursperperson

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

Source: Electricity Supply Association of Australia.

Fig. 3. Labour productivity in the Australian electricity supply industry, million kW h per person employed.

3 Load factorratio of annual generation to the peak generational load. Capacity factorratio of electricity generated

to effective plant capacity. Reserve plant margin is the difference between generating capacity and peak load expressed as

proportion of peak load;Bureau of Industry Economics (1996).



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Another method of determining TFP is to use DEA to apply the Malmquist procedure. This

approach can be applied to panel data to calculate indices of total factor productivity change,

technological change, technical efficiency change and scale efficiency change. These methods

are discussed in Fare, Grosskopf, Norris and Zhang (1994). The idea behind efficiency analysisis to use data collected for the state-based electricity sectors, and to derive what is known as the

dbest-practice frontierT. What constitutes a best-practice frontier can change over time;

therefore, it is important to incorporate this aspect of the production process. The Malmquist

total factor productivity index is one method of doing so. In effect, the Malmquist index derives

an efficiency measure for 1 year relative to the previous year, while allowing the technical

progress frontier to shift.4 This approach allows the decomposition of productivity change into

technical change and technical efficiency change. The Bureau of Industry Economics used this

approach in its report on the electricity industry in 1996 (Bureau of Industry Economics, 1996).

The previously mentioned exercises in the estimation of electricity supply industry

productivity approaches were completed too early in the process of electricity market industryrestructuring during the 1990s to make any conclusive remarks about the success of the process

at promoting greater efficiency and productivity. In more recent times, DEA has been used to

benchmark the performance of Australian electricity companies against overseas ones rather

than determine changes in productivity over time. Interest in the use of DEA in assessing the

performance of government bodies in this fashion in Australia rose throughout the 1990s. In

1997, the Committee of the Review of Government Services Provision, which had been

established in July 1993, published its work on DEA pointing out its usefulness in analysing

the efficiency of the provision of government services. In Australia, DEA has been used in a

variety of fields besides electricity including telecommunications (Whiteman and Pearson,

4 Logically, the frontier may shift outwards and reflect technical progress, or it may shift inwards and reflect technical

regression.

0

10

20

30

40

50

60

%

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

Source: Electricity Supply Association of Australia.

Fig. 4. Capacity usage in the Australian electricity supply industry %.



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1993), correctional services, hospitals and police patrols (Steering Committee, 1997), rail

(Productivity Commission, 2000) and vocational education and training (Abbott and

Doucouliagos, 2000a,b).

Whiteman and Bell (1994) used data from the Electricity Supply Association of Australia(1993) and data on international utilities from the Electricity Association of the United Kingdom

(1993) to benchmark the performance of Australian electricity companies with those overseas.

Two output measures were used (electricity generated and sales per customer). Inputs were

represented by thermal generating capacity (MW), other generating capacity (MW) and

employment. The results from this study indicated that after accounting for scale and other

external factors the technical efficiency of the Australian electricity supply industry was close to

the best-practice benchmark performance. The Electricity Supply Association of Australia also did

a similar study to measure the performance of the Australian electricity supply industry relative to

selected utilities for the period 19901991 (Electricity Supply Association of Australia, 1994).

Finally, Whiteman (1999)used the stochastic production frontier approach, as well as DEA, toestimate potential efficiency gains for Australian and international electricity suppliers. These

studies give a good indication of the degree to which there is scope to improve the degree of

efficiency and productivity to worlds best practice but do not give any indication of the degree to

which the Australian industry has improved its performance over the past decade.

In contrast to other measures of productivity, DEA requires data only on the physical

quantities of inputs employed and output produced if only technical and scale efficiency

indicators are to be estimated. To estimate allocative efficiency, factor prices are also needed.

Hence, the information requirements for DEA are fewer and less cumbersome than conventional

TFP analysis and the problem of allowing for different accounting treatments across

organisations does not arise. For this reason, in this paper, the DEA Malmquist approach isused to determine the total factor productivity measurements of the Australian State electricity

sectors over the period 1969 to 1999.

The primary source of data is the statistical publication of the Electricity Supply Association

of Australia (Electricity Supply Association of Australia, various issues). Interms of determining

the level of output for the industry, the amount of electricity consumed in each jurisdiction is

used. Inputs used include the capital stock, energy used (in TJ) and labour employed. Instead of

using some sort of accounting method to estimate the stock of capital, physical indicators of the

main capital assets used in electricity supply have been used (this follows the approach used by

Whiteman and Bell, 1994). The capital stock has been determined by taking the physical

amounts of lines, transmission station capacity and generation capacity.

Table 1

DEA results for the State electricity sectors

Malmquist index summary of State sectors

Efficiency

change

Technical

change

Pure efficiency

change

Scale efficiency

change

Total factor

productivity change

New South Wales 1.010 1.027 1.000 1.010 1.037

Victoria 1.011 1.008 1.000 1.011 1.019

Queensland 1.009 1.018 1.005 1.004 1.028South Australia 1.007 1.011 1.006 1.001 1.018

Western Australia 1.005 1.005 0.995 1.009 1.010

Tasmania 1.000 1.041 1.000 1.000 1.041

Australian mean 1.007 1.018 1.001 1.006 1.025



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4. Results

The results of the DEA modelling are derived from using the computer program DEAP (see

Coelli, 1996b). The results of Malmquist indices for the electricity industry in each State arereported inTable 1. Estimations for annual performance of all state industries during the period

of 1969 and 1999 are presented in Table 2and plotted inFigs. 5 and 6.

In Table 1, the efficiency indices for technical efficiency change, technical change, pure

efficiency change, scale efficiency change and total factor productivity change for electricity

companies in each state are listed. By assuming constant return to scale, technical efficiency

improved in five out the six states while leaving Tasmania unchanged. There was technical change

in the industry in all of the six states. On average, technical progress occurred at 1.8% annual

growth rate, with New South Wales recording 3% rate of growth and Tasmania 4.1%. If variable

returns to scale are assumed, technical efficiency in most states remained constant. However,

Table 2

DEA results for the Australian electricity industry 19691999

Malmquist index summary of firms over sample period

Efficiency

change

Technical

change

Pure efficiency

change

Scale efficiency

change

Total factor productivity

change

1969 1.000 1.000 1.000 1.000 1.000

1970 0.970 1.208 0.988 0.981 1.171

1971 1.082 0.819 1.020 1.061 0.887

1972 0.954 1.116 1.007 0.947 1.065

1973 1.004 1.061 1.012 0.992 1.065

1974 0.993 0.954 1.008 0.985 0.947

1975 1.080 0.911 1.016 1.063 0.983

1976 0.991 1.028 1.003 0.988 1.019

1977 0.894 1.373 0.944 0.947 1.228

1978 1.054 0.903 1.006 1.048 0.952

1979 0.969 0.868 1.018 0.951 0.841

1980 1.033 1.156 0.973 1.062 1.195

1981 1.006 0.849 0.954 1.055 0.854

1982 0.976 0.976 1.017 0.959 0.953

1983 1.077 0.901 1.033 1.043 0.971

1984 0.997 1.021 0.996 1.001 1.0181985 1.028 1.041 1.008 1.019 1.069

1986 1.008 1.297 1.003 1.005 1.308

1987 0.992 1.052 0.976 1.017 1.043

1988 1.017 0.871 1.031 0.987 0.886

1989 0.930 1.466 0.917 1.014 1.363

1990 1.127 0.645 1.132 0.996 0.727

1991 1.008 0.999 0.999 1.009 1.007

1992 1.003 1.370 0.996 1.007 1.374

1993 1.003 1.025 1.005 0.998 1.028

1994 1.018 1.023 0.997 1.021 1.041

1995 1.033 0.999 1.007 1.026 1.032

1996 1.003 1.036 1.003 1.001 1.0401997 0.990 1.025 0.986 1.004 1.014

1998 0.991 1.028 0.997 0.994 1.019

1999 1.009 0.944 0.999 1.010 0.952

Annual mean 1.007 1.018 1.001 1.006 1.025



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Western Australia recorded a slight fall in efficiency, while Queensland and South Australia had

experienced a small improvement in efficiency performance. Scale efficiency shows a similar

pattern to technical efficiency change. Accordingly, total factor productivity increased in all the

states with average annual growth rate of 2.5%. Tasmania and New South Wales are the two states

experiencing rapid productivity changes, mainly due to technical progress.

The annual means of the Malmquist indices are presented inTable 2. They are consistent with

those from the Australian means of Malmquist indices for each state. However, we observe wide

fluctuations in all the DEA indices over the 31-year period. Such fluctuations are not unusual in

DEA studies, since the DEA method is much sensitive to year-to-year changes in inputs and

outputs. In the case of the electricity industry, firms have fixed levels of capital and often fairly

fixed levels of labour endowment in the short run, but a fluctuating demand for their output

0.80.9

11.11.21.31.41.51.61.71.81.9

22.12.22.32.4

196

9

197

1

197

3

197

5

197

7

197

9

198

1

198

3

198

5

198

7

198

9

199

1

199

3

199

5

199

7

199

9

Year

Index

EffCh

TechCh

TFPCh

Fig. 5. Accumulative indices of efficiency charge, technical charge and total factor productivity charge for the Australian

electricity industry, 1969 to 1999.

0

0.5

1

1.5

2

2.5

3

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

TFPIndex

NSW

VIC

QLD

SA

WA

Fig. 6. Accumulative TPF for each state during 19691999.



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(electricity) over time. If a recession occurs, electricity sales fall but inputs will not change very

much, leading to a fall in levels of efficiency and productivity. Alternatively, if the industry has

under-utilised capacity and sales boom, then productivity levels will also rise significantly.

In the long run, investment in capital plant in the electricity industry takes place and technicalprogress occurs; however, the process can be a bit lumpy. Generation capacity is constructed in

advance of increases in electricity sales, therefore firms experience a sizeable increase in inputs

before the increases in output, which then lowers efficiency and productivity during and

immediately after the construction year, but gives rise to a potential rise in efficiency and

productivity in the following years. What is important, therefore, is the trend changes in

productivity and efficiency.

In Fig. 5, the three accumulative indices of efficiency change, technical changes and TFP

show no certain patterns of rise and fall over the early part of the sample period, but a general

trend of rising since the mid-1980s. Over the whole sample period, there is a 2.5% TFP growth

per year in the electricity industry. Part of the reason behind the poor performance inproductivity change prior to the mid-1980s can be explained in terms of the large-scale

construction of new generation capacity by the industry in advance of demand. The subsequent

increases can be then partially explained by the growth in demand and fuller utilisation of the

new capacity. However, there appears an acceleration in productivity growth after 1990, which

can be linked to the changes that have occurred to the industry in the 1990s. Although the

improved performance cannot be entirely attributed to the reform process, as improvements

occurred in the late 1980s, a great deal of the improvement in industry performance can be

related to the reform of the electricity industry.

InFig. 6, the accumulative total factor productivity indexes for five of the six states are given.

In each case, there has been a marked increase in the level of total factor productivity. Cautionshould be taken when comparing the total factor productivity of the different states as they do

each have individual characteristics that make this difficult. The stand out state is the Tasmanian

system, which is predominately hydro-generation compared to coal-fired stations that

predominate in the other states. Even amongst the other states, there is some divergence in

that the Victorian industry is based on brown rather than black coal which has implications for

the capital costs of generation capacity. Nonetheless, productivity changes for each state over

time are still useful in displaying the performance of the industry in each state.

5. Conclusion

In this paper, a DEA Malmquist approach has been used to estimate total factor productivity

of the electricity supply industry, broken down into its state-based constituent parts over the

period 1969 to 1999. The results indicate that there has been a substantial improvement in the

performance of the industry since the mid-1980s. The beginning of this improvement pre-dates

the substantial restructuring of the industry in the early 1990s although the improvement in the

productivity performance of the industry did speed up after 1991. It should be noted, however,

that, according to the study byWhiteman (1999), there is still scope for further improvements.

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