Sunday, 24 November 2013

Electricity competition - still a way to go

The great irony of New Zealand's wholesale electricity market is that, while we are all intensely proud of it, no-one wants to be exposed to its spot prices. That's why the vast bulk of electricity is generated and sold by vertically integrated firms: the gentailers.

None of these firms wants to split itself, because there is no ready market for the contracts that'd be needed by separated retailers and generators. Market forces are not about to change this structure anytime soon.

A vertical separation would almost certainly be more competitive though, if only because barriers to entry will fall, because its easier to enter one market than two. The lack of independent competition is most obvious at the retail level, where the very idea died in 2001 in response to the spectacular financial hemorrhage that killed On Energy when it ran out of contracted supply.

Mandating a vertical split has always been in the too-hard basket, but reforms that have a separating effect have been considered on-and-off since 2002. The Ministerial review of 2009 (pdf) also pursued the theme, using that typically Kiwi approach: delegate the solution to the industry. The relevant decisions were as follows.
All major generators (with over 500 MW of capacity) to put in place by 1 June 2010 an electricity hedge market with the following characteristics:
– standardised, tradable contracts
– a clearing house to act as a counter-party for all trades
– low barriers to participation and low transaction costs
– market makers (offering buy and sell prices with a maximum spread) to provide liquidity. 
An assessment to be made by 1 June 2011 of satisfactory market liquidity, defined as 3,000 GWh of ‘unmatched open interest’ (contracts without matching offsetting contracts).
Nice idea, but it didn't work, and was never going to according to EnergyLink whose June 2011 report to the EA says that
...open interest has grown steadily until it now sits at about 600 GWh. However, this is well short of the Government‟s 3,000 GWh target, and it is clear that this was never going to be achieved through organic growth.
The EA has since been chasing the gentailers along, trying to get them to make this work and staying upbeat about the project. But the latest report admitted that they're still short of the target
...record trading volumes, and sustained levels of UOI approaching 3,000GWh. Forward prices also continue to respond to market developments in a manner that appears mostly rational.
Mostly rational? That's a bit scary. And two years after the nominated date they're still "approaching" the liquidity target.

So anyway, lets review...

  1. More retail competition would be very good.  
  2. We've never seriously considered a vertical split to make that happen.
  3. Another option is for the incumbent generators to set up and supply a market for hedges.
  4. We've been asking them nicely to do that, for a few years.
  5. Its not going so well.

None of this is at all surprising. The gentailers don't want or need a hedge market: its only function is to help other firms to eat their lunch. The big question for me is over how long the EA will be content to stand on the sidelines cheering.

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