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NGC Winter Lecture: Infrastructure and the Economy

Hon Michael Cullen
22 June 2004
Speech Notes

NGC Winter Lecture Series: Infrastructure and the Economy

NGC Building, Level 8, 44 The Terrace, Wellington

The importance of infrastructure in the economy is not in dispute. Without good quality infrastructure it is hard for a country to sustain economic activity and growth. It is one of the key factors that investors – both domestic and overseas – consider when they are contemplating long-term investment. And it is probably fair to say that the infrastructure ‘bar’ is constantly being lifted, as businesses and consumers soon take improvements for granted and increase their expectations of our infrastructure. Conversely, any uncertainty about the quality and stability of key infrastructures can quickly undermine confidence.

Yet good infrastructure is not sufficient in itself to drive economic growth. It underpins and facilitates growth, but when it is functioning well most of us forget about it and get on with our business. Rather like good government, one might say.

The economics of infrastructure are also relatively straightforward. There is not a great deal of dispute over the conditions in which an effective set of infrastructures can be created and sustained:

- A stable macro economic climate is crucial, since infrastructure requires long term financial commitments and infrastructure assets, once created, often cannot be switched to an alternative use;

- A framework for efficient allocation is crucial for many kinds of infrastructure, and that usually means some form of demand management through user charges;

- A supportive investment climate is also essential, and that implies reliable information on risks and returns over the medium to long term, and a clear understanding of the mix of private and public benefit derived from infrastructure investment, mirrored in a disciplined approach to public sector financing;

- Finally, a high degree of regulatory stability and certainty is desirable, to enable planning over long time horizons and to allow the relative costs and benefits of various investment options to be assessed.

Unfortunately almost all of these conditions fall firmly into the category of ‘easier said than done’. If it is any comfort to us, this is not just New Zealand’s experience. As the British, the Italians and the Americans are finding, creating the right environment for investment in infrastructure and maintaining that environment over the long term, is a complicated and risky enterprise.

Infrastructure choices are frequently (though not always) hard choices. This is because of the scale of the financial commitment, the level of risk, the capacity for acute public concern, the environmental issues, and the difficult analytical and measurement issues around the treatment of natural monopolies and public good externalities.

At the same time, we should not exaggerate the perceived challenges to our infrastructure. In May of this year, the Ministry of Economic Development released New Zealand’s first nationwide infrastructure stocktake. A key component was an audit carried out by Price Waterhouse Coopers, which was largely reassuring, in that it showed that the major problem areas have been identified and work is under way towards resolving them. The main concerns were:

- Security of electricity supply, both in the short term (due to the shortcomings of a market model which does not factor in security margins), and in the long term (due to issues around the supply of gas in particular, but also the environmental issues around alternative fuels);

- A lack of investment in electricity transmission, brought about by a combination of land access issues and uncertainties over pricing and who should pay for investments;

- Road congestion, primarily in the Auckland region;

- Water allocation problems, due to a deficient statutory framework for prioritising water use; and

- Water quality problems in some areas.

Addressing these problems is one of the major concerns of my government. We recognise that infrastructure is a high stakes game; and that it is also something that is not amenable to quick fixes. At the same time, we have been reluctant to get drawn into any kind of infrastructure master plan. We need to coordinate efforts and deal with cross-cutting issues; but we believe that a series of sector specific strategies is the best way of getting the necessary traction.

So we have established a group of Infrastructure Ministers, which I chair, who meet regularly to oversee the various infrastructure strategies and address roadblocks.

There are four key areas we are focusing on.

First, we are increasing the overall level of expenditure on infrastructure, both by direct government expenditure and by encouraging others to invest. The 1990s was not a great decade for infrastructure investment in New Zealand. For example, in the years from 1994 to 2000 net purchase of physical assets by government amounted to only $5.8 billion or an average of $800 million per annum. In the period 2001 to 2008 we have increased that commitment to $8.6 billion or $1.1 billion per annum.

Since 2001, line-by-line consolidation of the Crown accounts also allows us to understand the level of investment by central government as well as Crown Entities and State Owned Enterprises. From 2001 to 2008 actual and forecast spending on purchase of physical assets rises to around $29 billion. This includes the rail network and Auckland transport. In addition to this, we have invested in a majority stake in Air New Zealand.

Investment by government and its agencies is only one part of the picture. We recognise that private investment is needed if we are to meet the demand for greater infrastructural capacity. There is a wide variation in the level of private investment in different types of infrastructure. Telecommunications is dominated by private investment, with public money focussed on access issues such as regional broadband rollout. Roading, on the other hand, has been an essentially public exercise due to the problems, both practical and political, in establishing a revenue stream that would provide a return on private investment.

So long as some basic preconditions are met, I have no problems with private investment in infrastructure. Most of the obstacles are technological or regulatory. The political obstacles – chiefly the perception that the private sector should not ‘own’ public amenities – may be overcome by a careful design of the investment vehicle, so as to ensure public access (in the form, say, of alternative routes alongside toll roads) while enabling private investors to generate returns. This is a matter that requires some degree of customisation around various types of infrastructural problems, although there are some attractions in a broader investment vehicle such as an infrastructure bond.

An infrastructure bond would differ from a conventional government bond in that it would be directly linked to new infrastructure investment (for example, new roads) and would be likely to have a significantly longer term of 20 to 25 years as opposed to the normal 5 to 12 year term. The Treasury and the Debt Management Office are currently looking into the feasibility of such a bond, and how it might be received by the markets. Infrastructure bonds related to roading imply, of course, that we grasp the nettle on the issue of toll roads.

Our second area of focus is the Resource Management Act. It is important that we do not fall into the trap of laying all of our infrastructure woes at the door of this Act. It is easy to make it the scapegoat for other barriers to investment, whether technical or cost-related.

Nevertheless, there are some aspects of the RMA that are clearly unhelpful from the point of view of national infrastructure priorities. Some of the key processes have become onerous, both in terms of cost and time. And while the Act was originally conceived to prevent the denial of natural justice in major resource decisions that prevailed under the Muldoon regime, it was not its intention to provide opponents of developments with opportunities for ‘greenmail’ and protracted filibustering.

So we are not revisiting the ideas and principles that underpin the RMA, because they are fundamentally sound. Rather, our aim is to get greater certainty and efficiency in the way the RMA operates. The review will focus on some areas where we believe there is room for improvement.

One example is the need to achieve the right balance of national and local interests. This is particularly important for transport and energy infrastructure where local authorities are increasingly being asked to consider projects that raise issues of national significance using an Act that provides little or no guidance on how competing national benefits and local costs should be weighed. There is no need for the Act to be silent on such matters, and I am confident we can find a way of expressing some straightforward principles in this regard.

The review will also look at improving the consent decision making process, to ensure more consistency between councils; reduce delays and costs; provide greater clarity and certainty for applicants; and largely eliminate opportunities for abuse of the process for personal gain, trade competition, or other vexatious reasons.

We will also be considering measures for building capacity and promoting best practice among the 86 councils who decide approximately 50,000 resource consents each year. While local authority practice has steadily improved, the performance of some councils could still be better.

We will be looking to introduce proposed RMA amendments to the House in September 2004 and those amendments should be passed in this term of Parliament.

A third focus for infrastructure ministers is to address specific regulatory issues that impinge upon different types of infrastructure. For example, last year we established the Electricity Commission and provided it with tools to deal with the failure of the electricity market to deal adequately with the issue of reserve capacity.

On the questions of securing long-term baseload electricity supply, we have recently made announcements on oil and gas exploration, which has become a crucial issue in light of the approaching depletion of the Maui gasfield. Our energy markets face significant uncertainty about fuel availability and forward prices, and also about how New Zealand’s commitments under the Kyoto Protocol will be worked out in practice.

Indigenous natural gas fuels about 20 percent of electricity generation, and around 75 percent of supply has been from the Maui field. That field will be significantly depleted by 2008, and although other gas fields will probably be sufficient to meet reticulated gas demand they are not sufficient to sustain electricity generation beyond about 2015. There are alternatives to indigenous gas, of course, including imported LNG, new hydro power, wind, geothermal and coal fired plant. These have the drawbacks of being more expensive than indigenous gas-fired generation, and, in the instance of coal, creating the added challenge of carbon emissions.

Alongside of options for maintaining cost-efficient electricity generation is the important objective of increasing the efficiency of electricity use. This is of course the greenest option of them all, and over time probably also the most cost effective; however the rate and level of efficiency improvements are uncertain, and we cannot afford to plan on the basis of assumptions that are hard to test.

For these reasons increasing the level of gas exploration over the next few years is an essential option for reducing uncertainty in the energy market and releasing pressure on sustainable energy development goals. New Zealand is blessed with a geology that means new discoveries of oil and gas are highly likely; but unfortunately we have a geography that makes exploration costly. Also, in spite of a favourable fiscal regime for petroleum exploration, a combination of low international oil prices (until recently, that is) and low gas prices (with a low Maui contract price dominating the market) has dampened interest in investing in exploration.

The market is starting to respond to the changing supply conditions, but the speed and extent of that response may not be sufficient. To address the situation, we are now seeking to encourage exploration for new gas reserves through a suite of proposed changes to taxation. The proposals will apply to production from fields discovered within the 30 June 2004 and 31 December 2009 period and include:

- reducing the ad valorem royalty [AVR] rate from 5 per cent to 1 per cent for gas (oil will remain at 5 per cent) for discoveries made within the period;

- allowing a deduction in relation to the accounting profit royalty [APR] on production from discoveries, within the period, of exploration and prospecting costs incurred in New Zealand and allowing such costs to be carried forward with interest;

- reducing the accounting profit royalty (APR) from 20 per cent to 15 per cent on the first $750 million [cumulative] gross sales of petroleum offshore and the first $250 million [cumulative] onshore on discoveries within the period.

The Associate Energy Minister Harry Duynhoven will lead consultations with industry on these proposals prior to their introduction through the Minerals Programme for Petroleum to have effect from next year. Any changes arising from the consultation will apply to production from fields discovered within the 30 June 2004 and 31 December 2009.

We have been keen to ensure the tax treatment of oil and gas exploration does not create unnecessary barriers and we will review the tax rules applying to non-resident drilling rig operators; aspects of the capital treatment of development expenditure; and the application of certain GST rules to the oil and gas industry.

In addition, the package proposes $15 million over three years for seismic mapping and increased resources to Crown Minerals to promote New Zealand overseas as a petroleum prospecting destination.

The changes to the royalty regime apply for a five year window only because they are designed to kick start exploration activity in the short term. The refinements to the tax regime will have a longer term impact.

Our fourth area of focus is forging the political consensus necessary to overcome infrastructure roadblocks. The major one has been literally a roadblock. I would not have the temerity to announce an end to Auckland’s transport woes, but I would say that the $1.62 billion investment package we announced in December last year is the most important development in several decades.

The commitment of resources is only one part of the package. For too long, confused and inefficient lines of responsibility have inhibited Auckland's transport development and the establishment of a single 'business-like' transport organisation for the Auckland region. The package provides a clear and fair solution to that conundrum.

To remind you of the main features, they are:

- A 5 cent increase in the fuel excise levy, and an equivalent rise in road user charges for vehicles five tonne and under, raising an estimated $200m annually for investment in transport around the country, including about $72m for Auckland per annum;

- An additional specific funding allocation for Auckland transport of an average $90 million per year over ten years;

- The development of options for raising revenue from tolls and borrowing in the future;

- The establishment of a single organisation accountable to the Auckland Regional Council (ARC), named the Auckland Regional Transport Authority (ARTA), with key responsibilities for land transport in Auckland;

- The establishment of an 'appointments panel', comprising seven representatives from the Auckland territorial authorities and eight representatives from the ARC, to select an independent 'business-like' board to run ARTA; and

- The transfer of the assets held by Infrastructure Auckland into a new body called Auckland Regional Holdings (ARH), also under the auspices of the ARC.

We have sought to strike a balance between the need for a regional approach to transport, and the need for input from the region's territorial authorities. With this in mind, the panel appointing the independent directors of ARTA will be chaired by the ARC but a majority of 10 members of the panel must agree before an appointment can be made.

ARTA’s role will be to make operational decisions that give effect to Auckland’s Regional Land Transport Strategy. ARTA will issue a public statement about what transport initiatives are needed to comply with this strategy, and it will decide (other than for state highways and the national rail network) where and when the initiatives will be put in place. ARTA will be responsible for seeing that they are implemented and funded according to plan.

So long as regional and territorial authorities in Auckland continue to meet their responsibilities for transport funding, Aucklanders will finally see the steady development of a world class, well integrated transport system, and we will start to see the economic costs that Auckland’s traffic congestion impose – estimated at around $1 billion annually – start to come down.

So to sum up, infrastructure is a major part of our economic strategy going forward. As the Price Waterhouse infrastructure stocktake confirms, any talk of a third world infrastructure is no more than scare mongering. There is no reason to panic, so long as we are prepared to sustain the necessary commitment to investment over a ten to twenty year period, and to address the few thorny issues around management of resources and pricing.

My government is prepared to sustain that investment. We see a crucial role for properly designed markets as a means of allocating resources efficiently and creating clear signals around investment opportunities and returns. But we also see a definite role for government in ensuring that regulatory frameworks function as they should, overseeing strategic investments of public money, and managing the often fraught political economy of decision-making around resource use.

Thank you.

ENDS

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