Hong Kong's electricity tax
4 January 2012

In all the noise surrounding the recent announcement of the 2012 tariffs by HK's two electricity monopolies, there is a socialist signal. In order to achieve lower (or even zero) rates of increase for low residential consumers, the power companies, under political pressure, have jacked up the rates they charge to higher residential consumers by a much larger percentage. This "tariff tilting", which has been going on for some years, amounts to a tax on larger residential consumers to subsidize the cost of electricity for smaller residential consumers and businesses. It's socialism with Hong Kong characteristics. Unlike almost anything else you can buy, the more electricity you buy, the more expensive it gets.

Under the Scheme of Control Agreement with the Government, each of the power companies is allowed to make a capped rate of return (9.99% after tax) on its average net fixed assets. Put simply, if anyone pays more than the average tariff, then someone else is paying less than the average in order to reach the same revenue for a given amount of electricity which then produces the target profit.

CLP

Here's the comparison of CLP's old and new tariff (all-in, including the so-called fuel clause charge):

As the table shows, consumers of more than 1300 units per month are now paying 27.7% more than last year for each additional unit. The units above 1,300 cost 56.0% more than the cheapest units, compared with only a 22.2% premium last year. This is what we mean by "tilting the tariff". Note that the above table includes the benefit of the 3.3 cents "Rent and Rates Special Rebate" which will be of limited duration and is subject to resolution of the court case, as we explain in our separate article. Without that rebate, you can add 3.5% to the increase in each band. Also note that CLP charges bimonthly, so we have halved the bimonthly bands to show the average monthly bands.

CLP has abandoned plans to flatten out its commercial or "General Service" tariff, which offers a slight discount to larger users, "until a wider public acceptance is reached". The all-in price (net of the rebate) will be $1.079 per unit on the first 5,000 units and $1.070 after that. That's a 5.0% increase in both cases. We note that on the other side of the fragrant harbour, HKE already charges commercial users a higher price for units consumed above 1,500 units/month, not a discount. So apparently this "public acceptance" depends on where your business is based. Overall, across all users (including bulk users - see below), CLP's average tariff for 2012 (net of rebate) is $0.987/unit, up 4.9% from 2011. So users on the General Service tariff are also paying more than the average tariff.

In 2012, the CLP residential tariff breaks even with the all-user tariff at 451 units per month (902 bimonthly), when the bill is $445.14. It breaks even with the General Service tariff at 913 units per month, when the bill is $985.22. If you consume more than that in any month, you will be paying more than a shop, office or hotel per unit, while subsidising those residential users who pay less. Incremental consumption above 1300 units per month costs you 33.5% more than the commercial tariff and a whopping 45.9% more than the all-user tariff. The expansion of the electricity tax is visible in the slope of the green curve below:

HKE

The Hongkong Electric Co., Ltd (HKE) already had a steep residential price curve before this year, so there was less potential to tilt it further, but they still steepened it a bit, and like CLP, they inserted a new upper tariff band. The residential tariff changed as follows:

So residential users of more than 1,500 units now pay 8.9% more for the additional units than last year. The additional units cost a whopping 80.4% more than the cheapest units, compared with a 70.1% premium in 2011, making HKE's electricity tax even higher than CLP's.

HKE's average all-user tariff rose by 6.3% from $1.233 to $1.311, while the commercial tariff now has 3 bands: $1.316 for the first 1,500 units, a new band of $1.421 for the next 18,500 units, and $1.446 above that. These represent band increases of 6.0%, 6.4% and 8.2% respectively. The residential tariff breaks even with the all-user tariff at 1,094 units, when the bill is $1,434.10. It breaks even with the Commercial Tariff at 1,110 units, when the bill is $1,460.63. Here are the 2011 and 2012 price curves:

Bulk discounts

Both companies offer discounts to large users who are willing to pay a capacity charge based on their maximum power demand (in kilovolt-amperes). CLP has a "Bulk Tariff" and is available to customers whose present or expected consumption is over 20,000 units per month. For even larger customers (railways and steel smelters spring to mind) there is a "Large Power Tariff". Presumably these tariffs work out materially cheaper for customers who choose them. HKE's tariff, or what it calls the Maximum Demand Tariff, offers savings for customers with at least 100 kVA of maximum power demand.

There is of course some sense in the lower tariffs for large users - if you have a factory, or run a train system like the MTR, then the power company has economies of scale because it can deliver electricity to your gate and then you handle your internal distribution, and only one bill is collected. But by the same argument, larger residential users should actually be getting a slight discount rather than paying extra, because the costs of metering, billing and collecting payment on such households is spread over more units of energy. The same logic lies behind CLP's commercial tariff. You will also find it in the residential tariff of The Hong Kong and China Gas Co Ltd (0003, also known as Towngas), where the price declines as the user's consumption increases. Towngas is not subject to any scheme of control, and gas is arguably less essential than electricity - you can cook and heat your water with electricity, but you can't run your lights or a TV with gas.

The steepening electricity tariff will make Towngas more attractive for cooking, water heating and clothes drying. Currently, the first 500 megajoules of Towngas energy are charged at 21.9 cents plus a fuel cost adjustment of 5.8 cents per MJ. One unit of electricity, a kilowatt-hour, is 3.6 MJ (a Joule is one Watt for one second), so the gas equivalent costs $0.9972. That makes gas energy cheaper after you have consumed your first 150 units of electricity in HKE's territory or 200 units in CLP's, although in the case of water heating, the energy efficiency of gas versus electric heaters also comes into play, as energy is lost in hot exhaust gases, so less is converted into hot water - an energy factor of around 0.7 compared with 0.9 for electric, so multiply that cost by about 1.3. Still, with HKE charging up to $1.683 per unit and CLP at $1.440, it may now be cheaper to burn gas than to pay the electricity companies to do it for you.

The socialist tariff

Regardless of the scheme of control, we see no reason why larger households (with more people and consumption) should be charged at higher rates than small ones, or why larger households should cross-subsidise commercial users which pay a lower tariff for the same amount of consumption. If this is about incentivising energy conservation, it is wrong to assume that households with higher consumption are less energy efficient - they may simply have more people in them, or they may spend more time at home (particularly if they are retired, looking after children, working from home or telecommuting). Why penalise them for living together rather than in separate homes on separate electricity meters? Why penalise them for spending more time at home than other people? The main incentive to save energy is already there in the basic cost of electricity.

This de facto electricity tax, which has become steeper in the new tariffs, is devised purely for political rather than economic reasons, in order to be able to show lower rates of increase (zero in CLP's case) for smaller consumers who tend to be correlated with smaller homes and lower incomes. By leaning on the electricity companies to do this, the Government is privatising social obligations. We call on the Government and the power companies to flatten the tariff for residential users to a single price per unit and bring it into line with the commercial tariff.

Apart from the steeply ramped residential tariff, the power companies also provide discounts for certain types of welfare recipients who are on  Comprehensive Social Security Assistance (CSSA). HKE offers a 60% discount on the first 200 units for the elderly (over 60), the disabled, single-parent families and the unemployed, while CLP provides a 50% discount on the first 200 units to elderly (over 60) CSSA recipients. All of these come at the expense of higher tariffs for other users so that the power companies can achieve their permitted return. It would be far better for the Government to increase CSSA payments so that recipients can afford electricity and require the power companies to charge all residential users the same flat tariff.

In a Legislative Council answer on 21-Dec-2011, the Government said that "this [tariff-tilting] arrangement will help promote energy conservation" - but in fact, what it does is to make electricity cheaper in real terms for the majority of households which are small, so if anything, it has the opposite effect. It is unlikely that reduced consumption by the minority in large households is enough to offset this.

Furthermore, not all small households are poor - some are bachelor bankers living in pricey little flats in mid-levels, or people with a pied-�-terre or a rural weekend home. So dishing out a subsidy in this way, taxing large consumers to subsidize small ones, is a scattergun approach to welfare, much of which misses its target. If people need help paying their electricity bills, that is what the social welfare system (including CSSA payments) is for. The Government should not shirk its responsibilities by trying to privatize social obligations, nor should it play politics with the tariff.

HKE v CLP

You may have noticed that HKE's 2012 average all-user tariff is 32.8% more than CLP's. Part of this may be due to the difference in energy sources: CLP has nuclear power from Daya Bay, while HKE does not. It may also be due to differences in the amount of fixed asset investment per unit of energy produced, such as the amount they spend on shiny headquarters and substations. Under the Scheme of Control agreed with the Government, the power companies are allowed to make a 9.99% rate of return on net fixed assets, known as the "permitted return", after tax but before interest on borrowed capital. The permitted return for CLP in 2010 was $8.568bn, or about 28.5% of revenue of $30.016bn, while the permitted return for HKE was $4.752bn, or 36.0% of revenue of $13.194bn. Nice work if you can get it.

Note that we said after tax: to make such a profit before tax (at a tax rate of 16.5%) you would need to make not 9.99% but 11.96% return on fixed assets.

We don't like the SoC - the fixed rate of return on investment bears no relation to the variable long-term cost of capital reflected by the corporate bond and equity markets, and by linking profits to fixed assets, the SoC incentivises companies to overinvest. It is undoubtedly true that overinvestment produces higher reliability of supply up to a point, but it does so with diminishing returns as we squeeze the last decimal points out of reliability. According to CLP's annual report, its average unplanned Customer Minutes Lost (CML) per year was 2.6 minutes in 2008-10, compared with 14 to 42 minutes in New York, Sydney and London. How much are you willing to pay for the difference? And how many planned minutes (or hours) of downtime for preventative maintenance is needed to achieve this reliability?

That said, the Government agreed to the current Scheme of Control, and shareholders of CLP and HKE (probably including your MPF fund if you have one) expect the companies to maximise their profits within the SoC. Indeed, it would be a breach of fiduciary duties for the directors to deliberately lower the tariff to make less than the allowed profit, unless they believed that this would be a net benefit to shareholders in the long run. We should note that the Government itself owns 2-3% of CLP Holdings Ltd (0002) and of Power Assets Holdings Ltd (0006, the owner of HKE) through the quasi-sovereign wealth fund known as the Exchange Fund (as well as smaller holdings via other Government funds), so it has a conflict of interests in this matter, and has done since it intervened in the stock market in 1998.

The cream

We couldn't conclude this article without mentioning that apart from the Scheme of Control profits, the power companies and their owners have also made large profits on the redevelopment of vacated sites over the years as HK's urban landscape has expanded into what used to be industrial areas. For each project, a land premium to Government to convert the land lease into residential use or expand its plot ratio, but that still left room for ample profit. Smaller sites of disused substations have also been developed.

HKE's old North Point power station became City Gardens after it was closed in 1978, and the power station intended to replace it on Ap Lei Chau, opened in 1968, stood for only about 20 years. In 1978, HKE was granted a new site on Lamma Island which came online in 1982, and then in the late 1980s and early 1990s the Ap Lei Chau site became the enormous 34-tower South Horizons development, in a joint venture with its immediate controlling shareholder Hutchison Whampoa Ltd (HWL, 0013) and its controlling shareholder Cheung Kong (Holdings) Ltd (CKH, 0001). HKE only got 20% of the upside on South Horizons, as the joint venture, Secan Ltd, was 20% owned by HKE, 50% by HWL and 30% by CKH and funded pro rata. Meanwhile CLP developed its old Hok Un power plant site into Laguna Verde, a 4m sq ft residential development in a 50:50 joint venture with CKH in the late 1990s and early 2000s.

© Webb-site.com, 2012

Organisations in this story

• CLP HOLDINGS LIMITED
• HONGKONG ELECTRIC COMPANY, LIMITED (THE)
• Power Assets Holdings Limited

Topics in this story

• Electricity

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