Fudging takes power out of paper savings

It is an interesting contention that households will save about $5 a month under a new deal that the Government has cut with the power supply companies.

Your correspondent does not have the figures on which it is based at hand but the central argument looks a little odd.

It is that these savings to the consumer will be achieved by lengthening the average depreciation period on plant and equipment to 35 years from 20 years.

Let's review how it works. The two power companies, CLP Holdings and Hongkong Electric, have monopolies in their areas of operation. To stop them from charging overly high tariffs, the Government regulates their earnings through what it calls schemes of control.

These limit their profits to a maximum of 13 per cent of their net investment in fixed assets. In other words, build more and you can charge more. There are a few refinements but we can ignore them here.

You get the figure of net investment in fixed assets by taking total expenditure on plant and equipment less the accumulated depreciation on it.

And this is the key. Say that you paid $100 for a machine that wears down quickly and that you are depreciating on a straight line basis over a useful life of six years.

In three years the machine is worth $50 and, using the 13 per cent figure, your annual permitted return on it has gone down to $6.50 from $13 when you bought it.

Now take a $100 machine that wears down slowly and is depreciated over 50 years. This comes to $2 off its book value every year and in three years it is worth $94. Using that 13 per cent again, your annual permitted return on it is now $12.22, much better than on the other machine.

So, in fact, you do not have to charge the consumer less under these schemes of control when you have longer depreciation periods. You can charge more.

What the Government actually seems to have done here is tell the power companies that they are not to build more than they really need.

Because of the way these schemes work, it has had to do it through longer depreciation. The companies cannot justify replacing old machines if their books now say those machines can still be used for years.

It may be true when they work out the profits that they could have booked on expensive new machines, less what they actually get from longer depreciation periods on existing machines bought at lower prices in the past, that they come to a monthly difference of $5 per household.

But it is a notional difference between actual returns on necessary investment and hypothetical returns on over-investment. It is not really a saving at all.

There is certainly room to scale down investment plans.

Apart from one anomalous upwards blip last year, the chart clearly shows that the longer-term trend in electricity consumption growth has been down.

The adjustment in depreciation is undoubtedly a crude way of doing things. The Government, however, is legally stuck with these old-fashioned schemes of control until a mid-term review in 2003 and a final expiry in 2008.

After that time we can get real deregulation the way it is now done abroad. We can split power generation and power distribution and open both fields to anyone who wants in.

You will then be able to choose from whom you want to buy your electricity, even from power plants in the mainland if you want. We will have a true market at last.

But that is in the future. For the moment we have to work with fudges like longer depreciation.