NBN: demand-side folly or supply-side win?

The NBN has spent so much time as a political football that we've forgotten to think of it in the simplest terms: as a way to right the imbalance of supply and demand. Getting this wrong, as we've seen in other industries, can be disastrous, which should be reason enough to support making the right investment now.

The resumption of healthy rainfalls in Victoria, which have pushed Melbourne's water storage past the 60 per cent mark, has spawned a quiet debate in that state over the wisdom of having committed $5.7 billion to build the massive Wonthaggi desalination plant — which, in a post-drought environment, is easy to portray as having been utterly unnecessary.

It sure didn't seem that way in 2007, however, when drought-stricken dams were plummeting towards single-digit capacity, livestock were living off the smell of a dusty trough and officials were handing out water-restriction fines if you so much as spat more than once a week. Perhaps that's why the inevitable questioning of the plant has been relatively muted: there was simply no better alternative, and despite its natural urge to attack Labor on every point, even Ted Baillieu's new Liberal government can't do anything but concede this argument.

If governments don't manage supply correctly, they might as well be heading over a waterfall in a barrel. (Waterfall image by Piotr Menducki, royalty free)

The long-term effects of the desalination plant will be quite interesting. Although its construction cost has been linked to rises in water bills and its prodigal consumption of electricity raises its own issues, the volume of water that it's slated to produce — around 150 billion litres per year, or one third of Melbourne's 2007 water consumption — should fundamentally alter the dynamics of the water market in that state.

Basic economic theory suggests that prices will decline as the additional volumes literally flood the market, increasing supply by one third. Real life may, of course, prove differently; utilities of all stripes are experts at justifying what, these days, is a never-ending series of price increases, and they're hardly going to give the new water away, even though they almost could. With water distribution and retail managed by a collection of localised monopolies, there are none of the proper competitive-market dynamics in place to allow competition to force down prices.

Compare this with Victoria's electricity industry, which has seen no meaningful investment in increasing generating capacity for many years. The introduction of completion in the state was a good step towards the ideal of a perfectly competitive market, but without new capacity, all you end up with is greater demand for the same limited resource. Hit-and-miss discussions about clean-generation projects have had varied outcomes, but those patchwork solutions offer little real relief to the crushing reality that supply can barely keep up.

If you think of national broadband capacity as an aggregated market, there's no question that there isn't enough broadband to go around — and what there is has been controlled by a monopolist with little interest in unilaterally increasing supply.

Prices, as a result, have been skyrocketing, and will continue to do so unless someone can figure out a way to flood the spot market with excess capacity that will push wholesale prices to more reasonable levels. Remember when California ran out of electricity after profit-minded energy traders artificially reduced peak-time supply and bankrupted Pacific Gas & Electric Company with the resulting higher prices? Since retail prices were capped by the state, the increase in supply-side costs squeezed PG&E into oblivion, and threatened to do the same with Southern California Edison.

What does this have to do with the NBN? Everything.

For all of its ability to polarise political and technological discussion, discussion of the NBN's proper role as a government-owned utility has so far been primarily utilitarian: we need better broadband, the "pro" argument goes, so we can do lots of great stuff. But while this has been adequate justification for many onlookers, it leaves so many speculative questions open that anti-NBN types have been able to argue against the investment.

Yet if you think of national broadband capacity as an aggregated market, there's no question that there isn't enough broadband to go around — and what there is has been controlled by a monopolist with little interest in unilaterally increasing supply. As a result, well wired city areas get lots of bandwidth, those in poorly served rural areas get almost none, and nearly everybody else vacillates between best-effort sort-of broadband, and the frustrating depredations of RIM-blocked new suburbs, where there's barely enough bandwidth to send a tweet. And it takes half an hour.

How much more capacity do we need to ensure the utility of our broadband networks? The Labor government argues that the existing model is flawed, and that patching up the network here and there is simply holding off the inevitable. As more and more homes come online — and expect to be able to consume more and more bandwidth — aggregate demand on our national broadband infrastructure will increase, with prices slowly rising (as they recently did at Internode).

This is the kind of situation in which Victoria's electricity market now finds itself, and one which will be replicated in other states as Australia's hunger for power continues to grow. If you think the profit-minded private-sector owners of NSW's electricity assets are going to voluntarily flood the market with new capacity so as to keep prices down, think again: when profit is at stake, the government's goal of delivering affordable energy falls by the wayside.

What is the NBN, but a way to deliver the same sort of hockey-stick jump in broadband capacity that the Wonthaggi desalination plant, and ventures like NextDC's national facilities or Macquarie Telecom's $60m datacentre, will deliver in other markets?

Then, think about the fact that IT tends to invest in cycles. Remember how investments in datacentres boomed in the early 2000s, and then dropped off a cliff as the market waited for enterprises to soak up surplus capacity? Now consider how investment in datacentre capacity has gone through the roof again as newly virtualised companies look for a place to put their cloud-hosted services.

In this context, the need for the NBN is clear: what is the network, in the end, but a way to deliver the same sort of hockey-stick jump in broadband capacity that the Wonthaggi desalination plant, and ventures like NextDC's national expansion or Macquarie Telecom's $60m Intellicentre 2 datacentre, will deliver in other markets?

Sure, as in those markets, there is likely to be excess capacity on the NBN at first, but you can bet your bottom dollar that it won't last. This is supported by the latest Cisco Visual Networking Index figures, which suggest that the number of Australian internet users will grow from 14 million to 20 million by 2015, with IP traffic growing from 4GB per person per year in 2010 to 22GB per person in 2015.

Whether you trust those figures or you don't, the underlying assumption of rapid growth in demand remains inviolable. Imagine if water or electricity consumption were expected to grow by the same amount, and then consider whether existing infrastructure could cope.

When you look beyond the political rhetoric, the NBN is really, fundamentally about nothing more than investing now to meet demand in the future. The Opposition's NBN plan, which amounts to little more than wrapping the knee of an injured player and giving him a shot of adrenaline, is focused on trying to dance ahead of that growth curve; Labor's, on jumping way ahead of the curve and waiting patiently as demand catches up with supply. Just as in Victoria's water market, the cost of a guaranteed long-term supply may seem like a lot now, but as it helps us ride out the inevitable droughts in the future, we'll forget that we ever questioned it.


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