Danger – high voltage market power

Power company profiteering has cost New Zealanders $4.3 billion since 2001 – and the Commerce Commission has spent more than three years learning that it’s powerless to stop it happening. Why?

It all seems so simple – but it isn’t.

A country that depends heavily on hydro power generation can expect electricity prices to rise in periods when demand is high and the lakes are low.

Surely, it takes more than that to justify consumer power prices increasing steadily year on year by a total of 72% over the last eight years – an increase that has seen a flood of complaints from major electricity users and a rising howl of public rage stirring the competition watchdogs at the Commerce Commission.

The Commission started pressing for answers late in 2003. It would not have been hard to identify the two publicly-listed companies – Contact Energy and TrustPower – and the three state-owned enterprises – Genesis, Meridian and Mighty River Power – which generate 92% of the power going onto the New Zealand wholesale market for auction every half hour of every day.

It would not have taken long to discover that the same companies were also buying 96% of the power available in the wholesale market to retail it on to you – as a residential, commercial or industrial consumer.

Clearly, the Big Five power companies have massive market power. But the Commission also had to consider the impacts of Transpower, the state-owned monopoly operating the national grid, and the 28 distribution businesses that provide the local lines which distribute power from the grid to consumers under contract to the retailers.

The distribution businesses are a relic of the power boards that used to handle both local line distribution and local retailing before the passage of Max Bradford’s Electricity Industry Reform Act of 1998.

The Act required full ownership separation between the distribution and retail sectors, and all the businesses – except TrustPower – opted to keep their lines and sell their retail operations. The Big Five generators were ready buyers.

Some of the local distribution businesses do compete to sell power to industrial and commercial consumers, but it is blindingly obvious from the wholesale market purchasing data that they provide little real competition for the Big Five “gentailers”, as the Commerce Commission calls them.

The Commission called in an acknowledged international electricity market expert, Professor Frank Wolak, to discover the source of the market forces that have been driving electricity prices inexorably upwards.

Wolak’s work was complicated by another flaw in the 1998 electricity industry reform.

It did not require the central collection and recording of data on the operation of the wholesale market.

Wolak has analysed market data in California, England, Wales, Columbia, Australia. Spain and the states of Pennsylvania, New Jersey, and Maryland – but New Zealand provided his toughest challenge. At the end of his first year’s work, he reported:

“The process of compiling and verifying the validity of the dataset for the New Zealand electricity supply industry has taken several orders of magnitude longer than it required for any of these projects. In fact, I believe that it would not be an exaggeration to say that it has taken me more time to compile and clean the datasets I have received for the New Zealand electricity supply industry than it has taken me to compile and validate the datasets used in all of these other projects put together.”

Wolak and the Commission have discounted Transpower and the local distribution businesses as power wielders in the market, and, for much of the time, they believe there is adequate competition between the Big Five gentailers.

However, there were periods in the dry winters of 2001, 2003 and 2006 when all but the smallest generator, TrustPower, had the unilateral ability to drive wholesale prices higher than competitive levels.

Wolak has used standard academic methodology to calculate that exercising their unilateral power added $4.3 billion to the value of their offerings in the wholesale market.

The problem for end consumers like you and me is that we have no idea what is happening in the wholesale market every half hour. As a result, we are unable to respond to its price signals.

The retailers – mainly the Big Five generators – smooth the flow of price changes through to their customers, which is why we have seen electricity prices tracking steadily higher year on year over the last eight years instead of spiking in the dry, cold years.

The Commission has found no hard evidence that the big gentailers’ actions are deliberately designed to hinder or deter their competitors. Their direct competitors are all still there – and all doing quite nicely.

However, it did examine one case of a gentailer [whose name has been deleted in the published report] which had been lobbying the government in 2007 to delay the construction of a generating station by a competitor. It notes that, later in the year, the government had subsequently imposed a 10-year moratorium on the construction of new baseload thermal generation by state-owned enterprises – and extended the moratorium by legislation to all generators the following year. The legislation was repealed last December by the incoming National-led government.

The Commission concluded there was insufficient evidence of a causative link between the lobbying and any detrimental effect in the market to merit giving it more attention. But it issued a thinly-veiled warning “that government agencies should be careful to ensure that market participants are not able to use regulatory interventions to enhance their market power.”

The Commission examined a number of allegations of collusion to diminish competition between the Big Five. It has issued a warning to TrustPower that a spurned approach to Genesis over “uneconomic” behaviour ran the risk of prosecution under the Commerce Act, and is in the process of alerting two other parties of another investigation it is about to commence.

Otherwise. the Commission could find no evidence of collusion among the gentailers to exert market power to the detriment of others.

After all, they do not have to collude to gain the kind of market power uncovered by Professor Wolak. They can read the flows of supply and demand easily enough to know when to exercise their own ability to influence wholesale prices.

As far as the Commission is concerned, the gentailers have simply been maximizing opportunities to increase profits to their shareholders that have been created by the structure, design and rules imposed on the electricity market by the government.

So, after more than three years of extensive, expensive investigation, the hot potato of power pricing is passed back to the government – from whence it came more than a decade ago.