Presentation by CEO
The Implications of Techonological Change in the Information Age for Utilities and Customers
Address by Keith Stamm - Chief Executive Officer
United Energy Limited
D 2000 Conference
November 1999
Ladies and Gentlemen,
Ten years ago at a conference like this, it would not have been necessary to ask you turn off your mobile phones. The rapid proliferation of mobile phones, email and voicemail in Australia and other developed countries has been a reminder of the influence technology has had on our lives and the significant changes that have impacted the way we do business.
In recent years, there has been increasing public awareness of the central importance of technological innovation as a driver of economic progress and higher living standards. Equally, it is central to the development of new industries and will either enhance or destroy most mature ones.
My remarks today are in three parts.
First, I will address the increasing rate of technological change throughout history. It is clear that this change will continue to be a key driver of increasing prosperity in developed and developing countries.
Second, I will discuss the rate of diffusion of potential technologies throughout businesses and our community.
And finally, I will conclude that, for natural monopolies such as utilities, the form of regulation to which we are subject is critical to the further development of our industry. The misapplication of regulation can stifle the adoption of the new technology necessary to ensure that we have First World infrastructure. The economic and societal consequences of such a misapplication of regulation should not be underestimated.
The stages of development
Throughout most of history, technology has been simple. Likewise, the communication, storage and retrieval of information has been very limited. It is worth taking a look at history to appreciate this point.
Our ancestors first appeared on the Savanna Plains of Africa about 200-thousand years ago. Then, over the next 150-thousand years the human race evolved to its current physiological state. That means that today, humans have the same physical characteristics and mental capacity as our ancestors had 50-thousand years ago.
For the purposes of this presentation I have depicted the progress of technology development over the last 50-thousand years on a twenty-four hour clock to emphasise the exponential rate of change we have seen in recent history. So, ignoring the first 150-thousand years we start our clock 50,000 years ago at zero hours.
Now for the first 40,000 years our ancestors were nomads, who were "hunters and gatherers". It took several-thousand acres of land to support a single family, with the result that there was little communication between these families.
Ten thousand years ago, they started planting crops, --signifying the beginning of the Agricultural Age. Initially, this reduced the land requirement from several thousand acres per family to about 25 acres. This of course brought families closer together and led to the formation of villages. On our twenty-four hour clock this transition did not occur until 7:08 PM.
As farming techniques improved and families were able to produce more food than they needed, some farmers took up specialist roles, as shopkeepers to sell the excess food and blacksmiths to manufacture farming implements. Others became soldiers and armies were formed but that is a different story.
Up until the invention of the printing press in 1450, knowledge-transfer was mainly verbal, so the pace of improvement was much slower than we are used to today.
Villages tended to be self-contained because of the cost and effort associated with transporting goods.
The steam-engine was invented in 1712, thrusting the world into the Industrial Age -on our clock it is now 11.50 PM. So, while the hunting and gathering lasted for 19 hours, the agricultural age lasted 4 hours and 50 minutes.
The steam engine took a number of forms including the locomotive. Of course, railroads increased mobility and dramatically decreased transportation costs.
The invention of the telegraph at about the same time made communication almost instantaneous and much cheaper than sending messages via horseback. Better communications and lower transportation costs meant villages no longer had to be fully self-supporting.
Naturally, not all these changes were universally welcomed, as was reflected in the phrase "Oh for the good old days", which was coined by Charles Hone in 1814.
Steam-engines also powered mills, which grew into factories. Factories grew into industries, and the villages where the workers lived turned into cities. Services such as banking and accounting evolved from this commercial growth.
Linking the steam-engine to a dynamo gave birth to the electricity industry.
This is probably a good point at which to recap: during the first 40-thousand years our ancestors were "hunters and gatherers"; the Agricultural Age 9,700 years; and the Industrial Age lasted some 250 years. Each new Age ushered in dramatic changes and overall improvement in human lifestyle.
When Francis Bacon penned the phrase "Knowledge is power" in 1597 at the height of the Renaissance, he had no idea how literal this statement would become on the brink of the new millennium.
'Eniac', the first computer, began operations in 1946 and used one thousand vacuum tubes. Incidentally, those tubes tended to attract moths. A year later, the transistor was invented, replacing vacuum tubes. Just as the steam engine led to the Industrial Age, the transistor signalled the birth of the Information Age - it leverages the human mind as much as steam-power leveraged human muscle during the Industrial Revolution.
This did not happen until 11.58 PM on our clock!!
In 1958, the integrated circuit, comprising two transistors, was developed. By 1971, Intel had squeezed 2,300 transistors onto an integrated circuit. The latest Pentium III has 28-million transistors!
As you know, modems allow the sharing of information between computers. Ten years ago, the transfer rate was about 2,400 bits per second over a standard telephone line. Today, the rate is more than 57,000 over the same line. DSL, cable modems and fibre optic cables have transmission rates which orders of magnitude higher than 57,000.
The combination of increased computer-processing power and increased communication bandwidth is creating a global "networked society". [Slide shows 11.59.53 PM] The ability to quickly store, retrieve and share information means that new discoveries can be instantly communicated and ideas challenged and improved upon immediately. Naturally, this further accelerates the rate of change.
Remember: 40,000 years, 9,700 years, 250 years and 50 years: each "age" is being compressed into ever shorter time-spans.
Today, the next revolution - the networking of economies - has only just begun, and it is comforting, as head of an energy utility, that electricity is the fuel that drives both the Information Age and the Networking of Economies.
Not only does electricity power a range of devices, it also provides a vehicle for communications signals.--- In this Digital Age, electric-powered devices convert bits of information into near-perfect sound quality, crystal-clear images and text that can be manipulated and instantly sent long distances.
The microprocessor has provided a quantum leap in the advantages electricity offers. And it is up to us, the utilities, to ensure that our infrastructure evolves to accommodate the more stringent requirements of this new technology.
Technology and the utilities
While the electricity supply industry has provided the fuel for this digital revolution, it is already being affected by the phenomenon itself. The electric grids we utilise in much of the world today were never designed with today's digital technology in mind. A new generation of digital controls is replacing analogue and pneumatic systems. Transmission and distribution networks are also slowly being upgraded with the same kind of advanced digital technologies that are bringing the efficiencies and precision that customers demand.
This supply side effect will help to satisfy increasing demand for reliability and quality of power. The digital technologies now being used in more and more homes and industries require high power quality to function efficiently since they are sensitive to even minor disturbances.
Something as simple as the routine switching of capacitors on a utility system can cause unprotected integrated circuits to malfunction. Whereas an analogue clock may simply skip a beat, a digital clock needs to be reset. The consequences of power disturbances will also increase for user industries, in terms of inconvenience, cost and quality of product. In other words, it affects their competitive advantage.
Moreover, as our industry becomes more contestable and there is increasing convergence of electricity, gas and other services, the benefits of having data collection, load research and profiling, aggregation of multiple meters, and large power billing all integrated into a single system will drive costs down and provide a competitive edge.
It goes without saying that the Internet and E-commerce is a burgeoning area with the potential to benefit both the utilities and our customers.
For example, sensor technology using fibre optics and magnetic resonance imaging is already boosting the efficiency of some power networks in Australia and overseas. In addition, advanced power electronics, based on semi conductor switching and converter devices, may transform a utility's ability to manage the power delivery system in real time.
There are a number of other areas of potential technological change.
Electro technologies include a range of new applications from microwave processing, electric separation and electric chemical synthesis in the chemicals industry to ultra sound processing, ozone disinfection and radio frequency drying technologies in the textile and carpet industries. In metals, electric arc furnaces are increasing as technology advances, as are infra red and ultra violet curing in metal finishing.
New power sources are emerging. The use of new fuel cells has the potential to become widespread in a few years. Fuel cell generators are highly efficient, converting a range of gases into electricity with low CO2 emissions. The first commercial units, expected in 2001, are forecast to give 40 per-cent fuel efficiency, with perhaps 70 per-cent efficiency if the excess heat is used to good purpose. Photovoltaic electricity is also expected to find increasing application, especially for areas not served by the power grid.
Technological change will drive future prosperity
While technology is recognised as a necessary source of productivity improvement --and increases in real incomes and living standards--, and an element in promoting economic growth, its role may well be even more critical in future.
Early thinkers on the subject such as Adam Smith, in 1776, saw technological change as a means for people to escape poverty and the drudgery of many aspects of agricultural and industrial work.
In 1858, Marx saw technological change as the prime-mover in capitalist development but drew implications that have failed to eventuate. This was the forerunner of the 'technology-as-Armageddon' groups that operate today.
The "technology-as-panacea" school of thought was evident in President Truman's famous 1949 inaugural speech where 'technology fixes' would solve the problems of the human condition, and later, with Prime Minister's Harold Wilson's remark about the 'white heat of technology change' solving the UK's dismal economic condition in the 1960s.
Joseph Schumpeter, writing in 1928, formed the principles that prevail today. He put technological change into a central role, helping to account for the short run instability of economies and for their long-run dynamic behaviour. He also showed that the forces shaping technological change are not so much scientific as economic. This offers the prospect of a virtuous circle of innovation and economic growth once certain market and regulatory failures are provided for.
Schumpeter's ideas were extensively tested in the 1960s and 1970s once the data and analytical tools were sufficient. Writers such as Denison, Samualson, Solow and, in Australia, Professor Lyddall, estimated that the actual contribution of technological change to a nation's productivity growth was about 60 per-cent, with the remainder largely accounted for by increased economies of scale. And of course today, we are seeing the impact of the economies of information networks. As pointed out by Bob Metcalfe, inventor of the ethernet and founder of 3com, the value of information networks grows geometrically with the number of users.
The view today is that technological change will soon become the predominant force in both productivity and economic growth in most O-E-C-D countries. This is a result of a number of factors including:
- the progress made on micro economic reform;
- the restructuring of economies,
- the lessening of the advantages of scale by microelectronics and other technological advances, and;
- declining rates of growth in labour forces.
This means that governments will need to take technological change even more seriously in economic policy making if living standards and economic growth are to continue to improve.
Equally, industries and firms will also need to focus on technology, as a matter of survival is an increasingly competitive world. We are not only faced with competition, which results from economies of scale, but again competition from economies of information networks.
When the rate of technological change was relatively modest, the rate of acceptance by the community and of diffusion throughout economies was largely identical. Of course, the Luddites smashed the new textile machines in England and similar episodes have occurred elsewhere. In Australia, there was widespread industrial unrest on the issue in the late 1970s and the Government established the Myer's Inquiry into the Impact of Technological Change (1979) to assess proposals for limiting and controlling the introduction of new advances.
It is worth putting some of the demons raised in the past to rest. First, these inquiries have found that technological change increases jobs not unemployment. Technology does enable repetitive jobs to be eliminated and what is often missed is the resultant need to reskill the workforce for the longer term. While there may be some short term disruption perceived by some sections of the workforce, lower prices and higher income effects, give rise to greater demand for the output of a range of industries.
By contrast, the non-adoption of technologies has been shown to result in job losses as firms lose-out to competitors overseas. Similarly, government protection measures such as tariffs slow down the pace of technological development, leading to fewer jobs and lower living standards over time.
While the advantages of technological change are clear, there may be increasing resistance to it as is implied in this chart. There is clearly a lag between the development of new technology and its uptake by the community. The problem, in part, may be that people have difficulty in putting aside the skills acquired in their youth and learning new ones. This did not matter when a working life encompassed one form of technology and limited incremental change.
In today's world it is necessary to relearn several times in a career. One implication is that the pace of technological diffusion will lag behind the rate of innovation, unless governments and firms focus on re-skilling and education. This is a major challenge facing our industry and underlines the need for us to invest heavily in communication and understanding our customers needs in designing service delivery and retail offerings.
The Role of Regulation
The other significant factor that will impact the introduction of new technology and the delivery of the socio-economic benefits I have mentioned, is regulation. I don't have to tell this audience that our industry is over-regulated and heavily-dependant on regulatory decisions to deliver the appropriate incentives for our shareholders to continue to invest in the industry.
Evidence from here and overseas indicates that the regulation now being implemented in many parts of Australia is unsound. It fails the objectives of policy makers in a number of ways and is likely to stifle the new technologies, ossifying the utility industries and denying the benefits of dynamic efficiency to customers. Eventually, this will reduce the competitiveness of Australia's energy-intensive industries, turning a national comparative advantage on its head.
By trying to predict the benefits of change and factoring these into their assessment of reasonable rates of return, regulators will actually discourage investment in the delivery of benefits to customers.
For example, the cost of computing as measured in Millions of Instructions Processed Per Seconds or MIPS was $5,000 US$ in 1985. By 1998, the cost had dropped to $1.78. Suppose that industry was regulated and in 1985, the Regulator had been able to se with perfect foresight that drop in cost and therefore set 1998 prices at that level. It is hard to imagine Intel and others deciding to invest billions of dollars in R&D and manufacturing plants if in 1985 the 1998 price at had been set at $1.78. The regulatory decision would have curbed the development of the technology.
Closer to home, United Energy is presently delivering a supply reliability performance well ahead of the regulated requirement. This achievement has involved the Company investing millions of dollars in new network technology. The investment was made to benefit customers in the expectation that the regulatory contract would allow United Energy to retain an acceptable return on its investment. Now we see the Regulator moving away from full glide path, thus reducing our capacity to continue to fund such improvements if those improvements exceed the bare minimum reliability requirements.
Furthermore the regulatory structure could actually penalise us for making this improvement.
Such outcomes are in contradiction of the intent of government policy and the objectives of the legislative frameworks surrounding the regulators. Professor Hilmer in his report to all Australian governments which laid the foundation for utility reform concluded that regulation should aim for:
"…the promotion of long term efficiency, taking into account the desirability of fostering investment, innovation and productivity improvement".
In a similar vein, the Victorian Government wrote to the State regulator in February this year, emphasising that, in formulating the regulatory framework, the priorities had been to:
"… encourage the development of a dynamic, efficient and sustainable electricity industry that would continue to deliver benefits to Victorian consumers into the future".
None of these objectives will be satisfied by the regulatory regimes being implemented. Moreover, despite the recent experiences of energy disruption in Canada, New Zealand and several States in Australia, there is little or no recognition by regulators that the economic and social value of reliability and quality of supply is high and will be increasing. Nor is it recognised that much of the electricity infrastructure is antiquated, a legacy we may say of the past policies of governments and not private enterprises. Yet, as I mentioned earlier, as customers take up digital and other technologies, they will no longer accept with equanimity even the momentary outages that come with open wire networks of some vintage.
But that infrastructure will not be quickly modernised and many of the potential technological developments hanging off the networks can not be taken up under the proposed regimes.
If there are inadequate or perverse incentives, or if the regimes are complex and subject to reversal, or are becoming more intrusive, the risks to the utilities and their investors will raise the required return on capital and, eventually, prices for end users of our products. If there is little confidence that utilities will be able to recover their investment, the opportunities for technological advances will simply not be taken up.
The problem is that Australian regulators, from first principles, are applying the wrong sort of model. They are applying what is known as command and control regimes based on cost of service and regulated rates of return that seek to match prices with costs. It is a corporate finance version of the perfect competition model of neo-classical economics in which, by definition, there is no technical progress or dynamic efficiency.
The most eminent of economists and former regulators both here and overseas have criticised the models now being implemented and my paper details their views. There will be no innovation or technical progress if the returns to companies are tied to the perfectly competitive rate. It is only the prospect of higher than perfectly competitive returns that will induce firms to undertake risky and uncertain innovational activities, and it is the surpluses from past earnings above the perfectly competitive level that are a necessary pre condition for firms to react to this incentive.
This model has a long and unchallenged pedigree, and is manifest in regulatory terms in what are called the total factor productivity and glide path models.
Professor Littlechild, perhaps the world's most eminent utility regulator, reaffirmed the need for such a model on his recent visit to Australia.
The former President of the Californian Public Utilities Commission, Dr Dan Fessler, has urged the Victorian regulator not to adopt the cost of service/rate of return model, citing weak and perverse incentives, rising costs, increasing intrusion, un-predictability and systemic failure.
At an ACCC forum in Australia, Professor Sandord Berg, Public Utility Research Center, (SIC), University of Florida, presented a paper criticising the cost of services model for the sorts of deficiencies I have mentioned, and pointed the way to efficient incentive regulation.
Emeritus Professor Brian Johns (former head of the BIE, Deputy Chairman of the TPC and Associate Commissioner of the ACCC) has submitted to the Victorian regulator that the model has serious disadvantages and raises the danger of inefficient investment levels in the Victorian electricity industry.
Even IPART, the Independent Pricing and Regulatory Tribunal in New South Wales recognises the disadvantages of this form of regulation.
The heads of regulatory agencies change every five years, but energy utilities have to make decisions on investments that last considerably longer. Of course, the ramifications of stifling innovation or inadequate investment and lack of dynamic efficiency will not start to emerge for some time, long after the regulator has left office. This suggests that the framework of controls over regulatory agencies are simply inadequate to the task as command and control regulation is becoming the "sea-anchor" which will slow down our economic development.
What is needed is a review into the adequacy of the legislative frameworks and the processes for regulating industries. This could test the consistency of regulatory proposals against the intent of policy and could recommend remedies where deficiencies are exposed. This may also involve changes to the legislation or other action such as the introduction of an expert review body.
Conclusion
In closing I would again highlight the exponential growth in the development of new technologies and the expectation that they will be a primary driver of our economic welfare into the future. As Utilities operating in this era, it is essential that we understand our customers needs and the inherent lag in community acceptance of rapid technological change. Above all, it is essential that regulatory regimes in our industry are not allowed to disadvantage Australian business and deny them the opportunity to create dynamic efficiency by the adoption of potential technological advances. The time for action is upon us if we are to avoid a severe loss of international competitiveness in a race which everyone knows is getting quicker by the minute.
