Markets are neither free nor efficient, and they are bad for the environment. While that may sound like a timeless left-wing credo, it's also a simple assessment of 20 years of privatisation and market-oriented restructuring of Australia's electricity industry.

It has become an unquestioned and unspoken assumption that the industry should be run according to market principles. As we head towards an emissions trading scheme, reducing the industry's greenhouse emissions is also seen as fundamentally a matter of market mechanisms.

But privatisation and imposed market mechanisms have already been a key barrier to reducing emissions — not to mention rising costs associated with payouts to some of the country's biggest polluters.

A recent study commissioned by Environment Victoria shows that under the package of measures accompanying the carbon price, Australia's dirtiest power stations will be gifted with a windfall of between $2.3 and $5.4 billion.

This outcome appears perverse and corrupt. Yet the industry's representative body claims it is fair and just. As The Age reported in February, "Chief executive of the Energy Supply Association of Australia, Matthew Warren, said carbon compensation was chiefly put in place to compensate for a reduction in the asset value of power stations as a result of the Emissions Trading Scheme".

If this precedent is followed, what will happen when climate action mandates the ending of coal mining? Coal companies, like mining companies worldwide, are counting the value of as yet unmined resources on their bottom line. Will the public purse be required to compensate coal barons for every dragline-bucket of coal that they do not mine and export?

The private owners of the power stations knew a carbon price scheme may be coming: it was in their contracts when they bought them. They were warned and have profited nicely in the meantime. They should not be compensated for a risk they were warned of. It is as perverse as it would be to compensate James Hardie for the loss of their asbestos business.

While Victoria and South Australia have the most privatised electricity industries, resisting complete privatisation in other states has not saved them from the logic of a private market. Following Victoria's lead, in the 1990s the eastern states and SA set up the National Electricity Market, modeled on failed electricity market systems in the UK and California.

The reasons given by governments for privatisation were to make power cheaper, in particular to attract and retain energy-intensive industries. But this is not what happened. In the one-sided “power pool” system, energy generators make bids for how much energy they can provide and at what price. The cheapest bids have to be accepted first, but the price they receive is not what they bid, but is set by the highest bid that is accepted.

This system can push up the price paid to all generators in a given period to enormous sums. It caused excessive price rises and blackouts in the UK and California, where it was abandoned. In Australia, where it did not result in such immediate and obvious disasters, it has been retained.

One of the main environmental outcomes of the National Electricity Market power pool was that the cheapest power took a larger market share — its low bids are accepted first. The cheapest is also the dirtiest power — Victoria's enormous brown coal generators. These generators tended to displace baseload capacity from the slightly less polluting black coal generators in NSW and Queensland, with brown coal's share of generation growing from 23 per cent to 31 per cent in the 10 years from 1992.

As the brown coal dinosaurs became more profitable, their expected retirement date kept being pushed back. Victoria's notorious Hazelwood power plant, the most polluting of all, was scheduled for decommissioning in 2006, but was granted a 30-year extension by the state Labor government.

Following on from this, the Gillard government's Clean Energy Future carbon price package promised to pay the dirtiest coal generators to close down under their "Contracts for Closure" scheme — but the government abandoned it at the last minute. Instead, we now see these most polluting power stations being compensated while staying open.

Contracts to close Victoria's brown coal operators would have made NSW's underused black coal generators more profitable, and they are only marginally less polluting. It would not necessarily have caused renewable energy replacements to be built. Either way, the coal industry is a winner.

While the market has favoured the dirtiest coal generators, renewable energy sources have required assistance from outside the electricity market to make any headway. The Renewable Energy Target has been organised by way of a market in Renewable Energy Certificates (REC). It sets a clear target of renewable energy, requiring that set amounts of RECs are bought by energy retailers (from renewable generators) to ensure that the target is met.

Yet the market was skewed by an influx of cheap, token RECs awarded to rooftop solar hot water systems during the Rudd government. The oversupply of these “phantom RECs” crashed the REC price, and energy retailers bought up cheap RECs — largely stalling the wind farm construction industry that had been doing so well until then.

The stalling of the wind industry also means that many big energy companies are now finding themselves without significant renewable capacity. Origin and Energy Australia have argued for a reduction in the Renewable Energy Target, instead of building new wind farms. The Coalition parties appear to be bowing to this pressure and it remains to be seen whether Labor will follow suit.

The electricity market has seen declining demand since 2008. In a market that was expected to keep growing for the foreseeable future, this is bad news for the corporate players.

Industry going offshore may account for some of the drop in demand – and accordingly, China's energy use and emissions have been rising sharply since 2000. On the other hand, domestic energy efficiency measures and the proliferation of solar panels (PV) on homes is probably a large part of the picture. As PV prices have dropped, Australians have installed more than two gigawatts of solar PV generating capacity on their roofs — enough, at peak output, to replace one large coal generator.

Such demand reduction lowers wholesale prices. In peak energy use periods, reduced demand means the most expensive bids don't get used in the power pool, keeping the overall price down. SA's regulator has even called for lower retail prices as a result of this effect.

State governments have slashed support for PV by attacking feed-in tariff schemes that rewarded PV owners, but the falling cost of PV technology, and the rising cost of electricity, means PV will remain popular. This is good news — as far as it goes.

To compensate for their declining market share, and partly to pay for recent investment in "poles and wires", electricity companies are raising prices. For this reason, energy utility AGL has pressured the SA government to cancel the drop in retail prices that the regulator mandated. The investment by homeowners installing solar is not being allowed to benefit all consumers as it ought to.

As these and other examples illustrate, privatisation has given us an ongoing legacy of increased and extended use of our dirtiest power stations — and ensured they remain immensely profitable to their owners. It has kept prices high and deterred investment in new clean energy sources.

Free marketeers could point to ways the current electricity market may be improved to function more fairly. They may also point to the old state electricity bodies as inefficient bureaucracies. However, we don't have to defend the old bureaucracy to look beyond the existing electricity market system. There is scope for much more community ownership: in Germany, over half of wind farms (for example) are owned by citizens such as farmers and co-operatives, not by large utilities.

The power pool system is unsuited to renewable energy — wind and solar in particular. Falling electricity demand combined with growth in renewable electricity are causing the existing system to strain. Instead of persisting with our inflexible, inequitable, and polluter-rewarding market, we should start thinking of newer, more accountable mechanisms to replace the failing system.