Saturday, 24 May 2014

What to do about electricity?

The Downstream conference is the biggest energy sector get together in NZ, and this year's event left me pessimistic about the outlook for NZ's electricity sector. As conference chair for the first day I was keen to understand the different perspectives, particularly on policy direction. Annoyingly, the options boil down to (a) more or the same or (b) NZ Power. I reckon we could do better than either of these.

There is one very good aspect of NZ Power: it stimulates competition in generation and in retail. That happens automatically because generators need to compete for contracts to supply the single buyer, which then has plenty of contracts to on-sell to independent retailers. Both of those would be major advances over what we have now.

As things stand now, if you want to build an electricity business you pretty much need to enter two industries at once: generation and retail. That is a barrier to competition, particularly on the retail side. NZ Power would cut the knot. Anyone with expertise in managing customers could get into electricity retailing - e.g. telcos, banks, merchandise retailers. Larger scale independent retailers would also subject the generation sector to well-informed, commercial-motivated scrutiny. I'd also expect to more progress on demand-side bidding into the wholesale market and a resulting expansion of "negawatt" firms which have no real traction in NZ.

There is a lot of obfuscation coming from those threatened by NZ Power and I don't buy most of the scare stories at all. But there are also some real concerns with the single buyer model. One is that it inserts a team of civil servants into the heart of an essential industry. That worries me because it ultimately makes a government minister look responsible for operational performance. I also doubt that Parliament will have the balls to write down generation asset values to the extent needed to deliver on the policy as announced, or even give clear guidance over which assets are of most concern.

But NZ Power definitely could work, and it could do so without compromising the really important things like efficient dispatch of power stations and setting marginal price in line with marginal costs. Insiders won't admit this, but the main reason gentailers are terrified of NZPower is that it could be very effective indeed.

For me though, the greatest pity is that those currently in charge of the electricity sector are so complacent and self-satisfied about it. If they were more ambitious, they could deliver the competitive benefits of NZ Power without taking operational control or mandating asset write-downs. This is the opportunity we are missing.

I am referring here to the Electricity Authority which is mounting something of a crusade(pdf) against NZ Power and claims to be quite happy with how the hedge market is working. The EA claims that power prices are actually too low, but they need to pull some pretty slippery moves to obtain that "result". This makes the EA look like an industry player rather than a dispassionate and independent agency. It's quite unfortunate, but let's just put it down to them being a tad defensive shall we?

Because the real issue is about the hedge market. Hedges are fixed price contracts for power. They give price certainty to retailers, so they can avoid being exposed to the volatile spot market. No-one wants to be exposed to the spot market. If this market is working well, then market forces have a decent chance of working towards the benefit of consumers.

At the Downstream conference I queried the EA about hedges for independent retailers. Their CEO was convinced that all the appropriate settings are in place. Apparently the plan is that an independent retailer will grow its customer base to the point where a gentailer has too much generation, at which point hedges will be willingly offered (rather than under threat of regulation as happens now). This is basically a chicken & egg strategy and its no surprise that potential independent retailers are generally too chicken to play along (hint: as a growing independent retail you will be winning customers off 5 different gentailers).

This looks to me like another triumph of economic theory over commercial common sense. Yes, you certainly could write down a model in which the EA's logic would lead inexorably towards a more liquid hedge market, but so what? If in the real world that process is highly uncertain and will in any case take decades, and you have alternative regulatory strategies available that could be much faster and more certain, then why are they not being actively assessed?

The only significant independent, Pulse, which is actually a tiny firm in the context of the industry, is agitating for change. Good luck to them. I hope they can change the EA's attitude. The longer the EA holds out, the more likely it is that something like NZPower will eventually be adopted.

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