KGB Interrogation: Michael Costa
In this week's KGB Interrogation, Business Spectator columnist James Thomson stood in for Stephen Bartholomeusz, who is on leave.
Alan Kohler: Michael Costa, thanks for agreeing to speak with us. This week you expressed some concerns about completing infrastructure projects in the light of shortages of people. Can you talk about how serious that is and what sort of solution you propose?
Michael Costa: Well I think it is an emerging problem. Its seriousness, I think, varies from area to area. We’ve had both positive and negative experiences in recent times. For example, our desalination plant – when we went out to tender on that, it ended up coming in under what we thought would be the cost, but we’ve had other projects, particularly in the rail area, where there’s clearly some significant skills shortages and where projects have come in above what our expectations were, so it’s a real problem. Our issue of course relates fundamentally to skills shortages, but there were some concerns that I expressed and other treasurers expressed about the fitness of the Australian construction market, particularly civil construction. How do you resolve that? What’s been proposed by the federal government, which is an increase in skilled migration, is the only solution in the short term.
AK: Do you think that the 457 visa program is adequate or not?
MC: Well really we don’t have any direct involvement in that – it’s really the people that are doing the construction for us. But certainly the broader proposition of insuring that we can access skilled labour on a global basis is one that we’d be able to argue is an appropriate course of action. Now there’s some complications for a place like Sydney, for example, and New South Wales more broadly in that in many cases migration adds to the very pressures that we’re trying to alleviate in terms of infrastructure demands in the short run, but certainly over the medium run, yes, it’s clearly part of the solution. Having a more competitive market’s also something that we would like to explore.
AK: Competitive? What sort of competitive market?
MC: In terms of construction, part of the problem – we’ve had discussions and I know other treasurers have had discussions with other players – is that global construction companies are wanting to get into the Australian market and part of their problem is firstly getting some sort of local base and, secondly, being able to phase their involvement and the size of some of the packages that we put out are part of the problem there. There’s also a domestic market that hasn’t been tapped. There are firms that are subcontractors to the majors that can’t get the extra lift in performance or lift their involvement to the next level because of balance sheet issues and there may be some scope to deal with that too in the way we put out our packages.
AK: I suppose there’s a limit to how much a state government can do to encourage more competition in the construction business?
MC: I think there’s a fairly significant limit to what we can do, other than this issue about how we tender for projects, and that’s something that I know all of the state treasurers and infrastructure ministers have raised. Essentially that’s again about this issue of balance sheets and whether our packages are too big and that has a tendency, if that is the case, that only the larger players can sustain not only the tendering cost but also the risks associated with these projects.
AK: There’s been some unhappy experiences with investors in the cross-city tunnel and the Lane Cove tunnel. I wonder whether you’ve got a specific problem in attracting money into New South Wales in the light of those experiences?
MC: No, I don’t think that’s the issue that I’m talking about. It’s the issue of supply on the construction site. Getting medium sized subcontractors to take the next step up and start taking some of the construction and project management risk rather than just being subcontractors, that’s really the challenge.
In terms of the cross-city tunnel and Lane Cove tunnel, I don’t think anybody’s arguing that the projects weren’t completed in a way that was world standard in terms of construction. They’re investment decisions. There are things like patronage risk and other things – anybody that goes into PPPs of that nature would expect to have that risk on their books, not ours.
AK: Just on another subject, can you bring us up to date with where you’re up to with the privatisation of the electricity assets?
MC: Well we’re privatising the retail, as you’re aware, and leasing our generators. Essentially at the moment we’ve put enabling legislation into the New South Wales Parliament. The New South Wales opposition has indicated that it has some concerns about supporting us at this stage until some conditions are met. I’m quite confident those conditions can be met. The sorts of things they’re talking about are having the Auditor General in New South Wales oversee, to some extent, the process.
There are some issues they’ve raised with us about the proceeds – how that’s going to be managed through the intergenerational community fund that we’re setting up, and some community impact statements. So we’re in the process of dealing with that, but in terms of advisors and the sort of mechanics of doing these processes we’re certainly well advanced.
James Thomson: Treasurer it’s not just the opposition that’s unhappy with parts of the privatisation. The unions are still fairly unhappy. Do you need to win them over?
MC: No. I mean the fact is we’ve indicated we’re proceeding. Certainly there’s been some concerns expressed by some of them… and some MPs that they’re likely not to support the package which will be largely academic if the opposition supports it – and I’d be surprised if the opposition didn’t support something that’s been fairly much part of their policy for a long period of time. I thought the focus of the question was in terms of the mechanics and that’s what I was focusing on. We’ve appointed advisors. We’ve got legislation drafted. We’re well advanced in terms of that part of the process. We’d like to see something out in the marketplace by the end of the year if that’s possible and that makes a lot of sense from our perspective.
Robert Gottliebsen: Mr Costa, Victoria fixed up its work practices in the power authorities before it privatised. Do you agree with the market estimates that if you did this in New South Wales you’d raise about a third more for New South Wales taxpayers if you took that course?
MC: I’ve never seen that estimate. I’m surprised at it because…
RG: It’s correct. Don’t worry about that.
MC: Well I don’t…I’ve seen no evidence…I mean you say it’s correct but I’ve seen no evidence certainly from our advisors that that is the case. New South Wales has gone through fairly extensive reform of its power industry in terms of generation as you would be aware. Labour costs are a very small component of the end cost of power generation and fuel costs are the biggest factor and the capital costs, and we did go through some fairly significant reforms. Nobody that’s interested in these entities has said to me that there’s huge labour inefficiencies, so I’m surprised at that assessment.
RG: It’s in the retail area where most of the labour inefficiencies are too.
MC: Well they’re not taking on the labour. Under our package the labour remains with the state. I mean they’re essentially in retail. What you’re purchasing is the customers themselves and the potential cash flow that comes from that. There won’t be any labour transactions in those areas.
AK: Are you a bit concerned you’ve missed the market in terms of potential to get a decent price from the equity markets?
MC: No, that’s not the indication we’ve got. I think there’s a couple of factors working towards at least supporting potential returns in this area. One is that the carbon trading issue is one that’s very alive for people that are exposed in either Victoria or Queensland, and getting a portfolio approach to your exposure I think will be important. Secondly there's the quality of the assets. In terms of the merit order, our assets are in the middle of the merit order. All of those things should hold up in terms of value. At least that’s the advice we’re getting.
JT: Can you just talk a bit more about the potential effect of climate change legislation on the price?
MC: Well there will be some… the Owen Report, the report we commissioned prior to undertaking this strategy, showed very clearly that Victorian brown coal generators are on a hypothetical carbon price would be greatly affected….more greatly affected than New South Wales generators because we’re burning a different fuel.
What we see as happening in that area is a change in where our generators are positioned in the national electricity market’s merit order but not a significant change in terms of value. You’ll see some value change across the portfolio but overall, because of them being in the middle, the value will hold up as a portfolio.
The real issue is, of course, in Victoria what happens to those generators – currently there’s a lot of uncertainty about the way this market’s going to operate and what sort of prices are likely to be there. The Garnaut process is one that the New South Wales government’s taken a critical view of. We think there are some assumptions in some of Professor Garnaut’s modelling that will not hold up in reality. For example, price pass-throughs, the frictionless pass-through of any additional costs. We’re not as confident as the Professor is on that particular issue, but overall given the quality of the assets we don’t expect a huge impact on our price.
RG: Are you aware of the Santos estimate that says that at a $50 carbon price, the can take carbon out of the New South Wales power stations, and perhaps even Victorian ones too, and dump it, put it in the Cooper Basin?
MC: Mmm. I’m aware of that but I don’t see what the relevance is for our generation assets. The reality is that the carbon price, even if you assume that Professor Garnaut’s right, is seen as a pass through. The real issue for me is whether it makes sense to have a carbon trading regime – remember, the objective being of course to change people’s demand patterns – that is predicated on a significant compensation package that in effect mitigates against the very pricing rules you’re talking about. And all of that coming out of what I would describe at this stage as a magic pudding, which is the auctioning of carbon certificates. I just don’t think it adds up.
The issue for investors in New South Wales power has been the question of sovereign risk – whether government should be able to come along and change rules half way through a process without an appropriate phase-in time, so our debate is about how you phase it in. I mean whether it’s $50 or $60 is really largely irrelevant for us other than what it does to the cost structure of the generators. If you get a position where the carbon price is higher than the fuel cost, for example, and higher than the return you’re likely to generate in terms of the electricity market. Clearly you can’t produce power and that is, I think, the position you’ll find some of the Victorian generators in but not New South Wales.
RG: The latest fall in employment came in New South Wales. What do you put that down to?
MC: Oh there’s no question that the interest rate pressures are hurting the New South Wales economy. I mean that’s what it’s designed for. Monetary policy is designed to slow down the Western Australian economy and the Queensland economy at the expense of New South Wales and Victoria, I’d argue. And that’s what we’re seeing. Where are we seeing it? We’re seeing it primarily in the property sector. Our housing demand has been flat for nearly two years since the interest rate increases started and I see no reason why that would change.
RG: There’s no question that you’re quite right that the interest rates are affecting all of Australia but they seem to be affecting New South Wales more and the business community puts that down to three things. Or lots of things, but three important things. The New South Wales industrial relations laws. The New South Wales occupational health and safety rules and the slump in western Sydney which was partly due to bad local government and land zoning. Do you agree with that?
MC: I think that all three of those things are probably exaggerated and I’ve had may discussions with the business community where they’ve expressed concerns. They have expressed concerns about occupational health and safety. There’s no doubt about that. They’d like to see some harmonisation of that but nobody’s actually said to me that industrial relations laws have been the problem with investment. In fact we’ve had fairly high levels of business investment.
RG: No it’s not investment, it’s employment.
MC: Yeah but employment, we’re at record numbers. We’ve got skill shortages. I’ve just had a meeting with the coal producers in the Hunter Valley. I can tell you what the problem is. It’s skills. And there are certainly pockets of higher than average levels of unemployment, but in a region like the Hunter, 10 years ago, we were above the state average. Now we’re at the State average or below and certainly with fairly significant skill shortages. Coal miners are talking about putting a new coal loader in, about production levels going up by 30 per cent. So I think it’s a bit simplistic to generalise.
There’s no doubt there’s a problem in western Sydney and south western Sydney largely in the housing area and traditionally it has also had higher levels of state average unemployment but as you increase interest rates you’re going to see those consequences come through, but we’re off a historically low base at the moment. We’ve still got unemployment rates at levels that most people haven’t seen for 15 years.
RG: Would you embrace the Commonwealth industrial relations laws?
MC: What do you mean?
RG: Will you cede the power to the Commonwealth?
MC: Well…
RG: There’s speculation on that this morning in the media.
MC: Well look, there’s no doubt – and I’m talking as the treasurer, not as the cabinet because the cabinet hasn’t made a decision on these things – certainly there was a report in The Australian that I’ve asked for an assessment of the cost of the state system and potential savings that might derive from our budget’s point of view, not from the economy’s point of view, of a movement to a federal system. And I suppose my view is that if you’ve got an ability to take some costs out of the budget you would have at least examined those. The real issue here is not whether it’s state or federal. It’s whether there’s a streamlined approach and the level of regulation that’s implied in the industrial relations law is appropriate to what industry and employees require.
RG: Do you realise that New South Wales is out of step with the rest of the country in this area?
MC: How’s that?
RG: Well the practices in New South Wales are different to the practices in Queensland and in Victoria and other places.
MC: On what issue are you talking about though? Occupational health and safety.
RG: Yes that, and also industrial relations as well.
MC: Well I think you’re wrong there. Queensland industrial relations to still a strong state-based system. As a matter of fact, the unions up there are very passionate about their state system, so that’s just factually wrong. Certainly in Victoria there’s a different arrangement that’s a result of the Kennett years.
RG: Queensland’s situation is made a lot better because their system seems to work better. The Queensland system looks to be similar to New South Wales but in operation it’s quite different and it’s New South Wales where the problem is.
MC: Well that’s a view I’d have an argument about if we had more time.
RG: Are you aware Queensland sees itself sucking young people out of Sydney. A lot of their budget moves are designed just to do that.
MC: I was just up in Mackay on the weekend. I have to say that the local press was very interesting. It was in fact very reminiscent of Sydney, both in terms of infrastructure bottlenecks. In terms of challenges. In terms of pay and conditions for their police officers, for example, and also challenges in terms of the tourism industry and other industries that seem to be under some pressure there.
I think these sorts of simplistic relative economic comparisons are things that I don’t really subscribe to. I mean I’ve often said that I don’t believe we have a state economy, we have a national economy and it’s even questionable whether we have a national economy in a globalised world so to make these sorts of comparisons I think is very difficult.
State budgets are essentially accounting entities. The influence of a state government on an economy – and I do concede what you said about regulation, and that’s a negative influence by and large, you can get it wrong and cause difficulties – but the ability to influence a state economy through a state budget is pretty limited.
AK: Speaking of simplistic economic comparisons, is western Sydney or south western Sydney in a recession or likely to be in a recession as the national growth in Australia slows?
MC: I don’t know how you can speculate on a recession in south western Sydney. I saw this done the other day in the Sydney media, where some people claim there was a recession in restaurants, and take away foods were doing better. I mean you can take these analogies into the realm of idiocy.
The fact of the matter is that south western Sydney’s got some very fundamental problems. Those problems largely relate to social and demographic issues. Things like school retention rates, participation rates, education levels and those sorts of things are the big drivers. Whether you can then generalise on the basis of macro-economic concepts of recession to very localised areas is a bit hard for me to understand how you do that. But having said that I’m not going to dispute the proposition that we have pockets of disadvantage in New South Wales and even in the Hunter at the moment I can point to areas that would have that social disadvantage even though the economy’s booming. So it’s a very hard question to answer in those terms.
AK: Would you say as the treasurer of New South Wales that interest rates have gone up enough now?
MC: Interest rates are hurting us. I got our treasury to do some analysis based on the Taylor rule that was very fashionable recently and a neutral rate in New South Wales has probably well and truly been exceeded in terms of monetary policy and the interesting thing is that it hasn’t actually slowed Western Australia down that significantly so it’s very much a case that monetary policy’s the wrong instrument.
I think the supply side constraints is what the previous federal government failed to address… and the current federal government should be looking in conjunction with the states to get some of the people that don’t have the skills in those disadvantaged areas into the labour force with some skills. I think that’s where we should have been looking.
AK: What did your treasury department tell you the neutral rate in New South Wales is?
MC: Well this was done a few months back before some interest rate increases, but at the time the general interest rate was about 7.25 and our neutral rate was around 5.0 or 5.25. So it’s really impacting on us.
AK: Thanks very much Treasurer. It’s been a pleasure talking to you.
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