Former Economics Editor of the NZ Herald

Brian Fallow: Extra for power - it's only fair

Here’s a message for Aucklanders grumpy about paying a little more on their electricity bill: Get over it.
Illustration / Anna Crichton
Illustration / Anna Crichton

Unwinding a cross-subsidy is never popular among those who have been on the bludger's end of one.

But Aucklanders grumpy about the prospect of having to pay about $1 a week more per household for their power need to get over it.

The draft changes to the way the costs of the national grid are allocated, which the Electricity Authority released this week, are intended to make the system fairer and more efficient, by getting a better alignment between those who benefit from upgrades to the grid and those who pay for them.

Transpower has spent billions in recent years on the grid, mainly to serve Auckland's growing population.

And fair enough. It is not good to be on the wrong side of a bottleneck in the transmission grid. Because of the way wholesale electricity prices are set, if there is a constraint on the grid, prices downstream of it will rise, sometimes steeply, while those upstream of it fall. And a tight enough bottleneck can compromise security of supply.

How much return Transpower can earn on its investment is regulated by the Commerce Commission; it is a monopoly after all. Its transmission revenue currently runs at just over $900 million a year.

But how that sum is apportioned depends on a complex set of rules - the transmission pricing mechanism - for which the Electricity Authority is responsible and which it plans to reform, after years of sometimes rancorous argy bargy within the industry.

At least in the short term it is a zero-sum game. Auckland, Northland, the West Coast of the South Island and the area around Ashburton will pay more, but most of the rest of the country will pay less.

Only about three-eighths of transmission charges will move to the new "area-of-benefit" basis because it only applies to relatively recent (since 2004), and future, expenditure on the national grid, most of which is decades old.

The changes will not kick in for another three years.

A typical household customer of Vector would pay $58 a year more than under the status quo, the authority reckons, a rise of about 3.4 per cent on their overall power bill. A customer of the Christchurch-based lines company Orion can expect a $48 a year saving and Wellington Electricity customers a $36 fall.

Vector chief executive Simon Mackenzie is unimpressed, even though lines companies like Vector, as monopolies, can simply pass on the higher cost to their customers.

"One of the Electricity Authority's core principles is to charge those parties benefiting from being connected to Transpower's grid," he said. "Given that electricity generators are totally reliant on the grid to sell their product, it is hard to fathom why consumers are being asked to pay over 90 per cent of the transmission costs.

"How can the EA reconcile the fact that generators are only required to contribute less than 9 per cent to the cost of transmission? It makes little sense and is inherently unfair."

The generators are also the electricity retailers to whom we pay our power bills. In the end, it will be the consumer who pays.

But Mackenzie's point is probably that one thing the authority wants to influence by a more efficient pricing methodology is generators' decisions about where to locate new generation.

The Electricity Authority has considerably modified its proposal from what it outlined last year, in ways that reduce the increase northern consumers will face.

But the net effect is still a smaller subsidy flowing from southern consumers to northern ones.

The biggest and southernmost consumer, the aluminium smelter at Tiwai Point, is looking at a cut of at least $21 million, or about a third, in its transmission costs.

That is less than the $50 million it might have hoped for under earlier iterations of the authority's plan.

But that is not the end of the story.

The smelter's owners will be able to seek a discount under something called the prudent discount policy. It is already allowed under the existing transmission pricing mechanism, but the authority wants to broaden the grounds for granting a discount.

The idea is that it would be a perverse outcome for New Zealand Inc if transmission costs were the straw that broke the camel's back in terms of the smelter's continuing commercial viability.

If it shut down, Transpower would still get its $900 million a year but its remaining customers would have to pick up the smelter's share. It would also face substantial costs expanding the grid so power from Manapouri could flow north instead and those costs would have to be recovered.

There are conditions around such a concession. The smelter would have to show that transmission charges represented a material part of its input costs and profits.

It would then have to show there was a "material risk" that transmission charges would cause the company to close its plant and so disconnect from the grid, and that it had taken reasonable steps to remain viable as a going concern, by addressing other costs it faces.

If its viability was threatened by low product prices on world markets, the concession is likely to be linked to those prices, so it would not continue once they recovered.

Even at depressed prices, aluminium exports are worth $1 billion a year at a time when New Zealand is running a trade deficit of $3.8 billion.

As authority chairman Brent Layton put it, "In competitive markets suppliers do give discounts to keep a major customer."

The smelter's closure would be a seismic event in the electricity sector. It would cut national demand for electricity by an eighth and leave generators with stranded assets.

That is why other generators as well as Manapouri's owner, Meridian, came to the party when the smelter's power contract was renegotiated last year, limiting the increase in the average power price it pays compared with what it would have been under the previous contract.

$58 - Extra annual cost for typical Vector household customer

$48 - Annual saving for an Orion (Christchurch) customer

$36 - Saving for a Wellington Electricity customer

Electricity Authority estimates

Read a Consumer's Guide to the Transmission Pricing Methodology:

Debate on this article is now closed.

- NZ Herald

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Former Economics Editor of the NZ Herald

Brian Fallow is a former economics editor for the New Zealand Herald. A Southlander happily transplanted to Wellington, he has been a journalist since 1984 and has covered the economy and related areas of public policy for the Herald since 1995. Why the economy? Because it is where we all live and because the forces at work in it can really mess up people's lives if we are not careful.

Read more by Brian Fallow

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