Brian Fallow

The Economics Editor of the NZ Herald

Vote will decide who controls price you pay for electricity

The two sides of politics are divided on how best to rein in rising power bills -- regulation or competition -- writes Brian Fallow

NZ Power - proposed by Labour and the Greens - would decide which power stations would run and how much they would be paid.
NZ Power - proposed by Labour and the Greens - would decide which power stations would run and how much they would be paid.

The electricity sector will be in for radical upheaval if there is a change of government.

Power bills have been rising relentlessly. Electricity prices rose 12.1 per cent over the three years to June, according to Statistics New Zealand's consumers price index. That outstrips the cumulative rise in the average wage (7.7 per cent) and general inflation (3.3 per cent) over the same three-year period.

The two sides of politics are divided on how best to rein that in -- competition or regulation.

The National Government introduced changes in 2010 intended to make the energy side of the industry more competitive and points to various measures to indicate they have had that effect.

Read the Herald's full Election 2014 coverage here.

But Labour and the Greens see a structural rip-off in the way wholesale power prices are set. They announced in April last year a plan to scrap the wholesale electricity market set up in the 1990s and replace it with a single buyer in the form of a Crown entity called New Zealand Power, inserted between generators and electricity retailers (which are generally the same companies).

NZ Power would decide which power stations would run when and how much they would be paid for their electricity. That would be based on fuel costs -- nothing in the case of hydro and wind -- and a fair return on the historic cost of the generating assets. There is a lot of room for argument about what a fair return would be and how to define the historic cost.

New generating capacity would be commissioned through a competitive tender process.

It would be a return, in short, to central planning as in the days of the old New Zealand Electricity Department, except that this time the capital at risk largely belongs to private investors, not taxpayers.

However, any relief for hard-pressed households -- around $300 a year on average, Labour claims -- that might result from such a radical change is some way off. Labour's alternative Budget books a cost to the taxpayer from NZ Power of around $90 million a year, but not until the 2017/18 financial year.

"We haven't put a strict date on it because we have to work through the details," Labour energy spokesman David Shearer said.

NZ Power's critics say it is badly targeted, arguing that most of the recent rises in power bills do not reflect the cost of energy but higher charges for getting the power to us, over the national grid (which has had billions of dollars spent on upgrading it) and the local lines networks.

Both are monopolies whose charges are regulated by the Commerce Commission and would not be affected by any changes to the wholesale electricity market.

The Ministry of Business, Innovation and Employment undertakes a quarterly survey of domestic energy prices. It has recorded a rise of 2c a kilowatt hour or 8 per cent over the three years to May 2014 (only two-thirds of the rise the statisticians' CPI reports), but 90 per cent of the increase is in line charges.

"I've spoken to the lines companies about that and they dispute it," Mr Shearer said.

So we have both sides of the industry, energy and lines, blaming the other for higher power bills and about the only thing politicians can agree on is the need for greater transparency in this area.

Another criticism of the NZ Power plan is that if the real problem is energy poverty, that is more about incomes and insulation standards in housing than the fact that hydro generators don't have to pay for their fuel or that the cost of building their dams was heavily subsidised by the taxpayers of old.

"That's a fair point. If people are poor they will start making choices around food or electricity or petrol or whatever," Mr Shearer said. "We aren't going to be reckless about this. We will work through it cautiously. But we are not satisfied that what we have got at the moment will meet the future needs of New Zealand or is fair on consumers."

NZ Power's critics say any reform has to be fair on investors too. The wholesale market is designed to push average wholesale prices up to the long-run marginal cost of new generation, to ensure that the cheapest next increment in generating capacity gets built and the lights stay on.

Labour and the Greens say that system allows generators whose fuel costs are minimal and whose capital costs are long sunk to make out like bandits.

But the generators are also electricity retailers. They are both buying and selling in the wholesale market and the impact of wholesale prices on their profitability will depend on whether they are net buyers or net sellers in any given half-hour period at any given point in the grid. They try to minimise that commercial risk.

What scrapping the market will do, however, is remove price signals about whether the hydrology is looking menacing and it is worth conserving water in the lakes and cranking up gas-fired generation earlier than usual. That decision would be left instead to NZ Power's engineers and their mathematical models.

And regulating to eliminate generators' pricing power could distort the economics of investment in new generation in a way that would crowd private capital out, the critics argue.

Mr Shearer argues that is backward-looking, puts too much emphasis on the supply side and ignores the potential for technology and public policy to reduce demand through things like more-efficient appliances and more insulation.

"We are not necessarily looking at too much more [generation]. The world is changing quite quickly."

Single-buyer model justnationalisation: ex-boss

Doug Heffernan is not a fan of what Labour and the Greens plan to do to the electricity sector.

Dr Heffernan retired last Friday as chief executive of Mighty River Power after nearly 40 years in the industry, during which he witnessed radical structural changes.

He worked for the New Zealand Electricity Department and its corporatised successor, ECNZ. He was chief executive of Power New Zealand, before the local power companies were split into lines and retail energy businesses.


Former power boss Doug Heffernan says a diversity of thinking creates better outcomes. Photo / APN

And he had been chief executive of Mighty River Power since it was carved out of ECNZ as a state-owned enterprise and latterly as a listed company under the mixed-ownership model.

Dr Heffernan views the Labour/Greens' New Zealand Power plan as a political attempt to derail partial privatisation.

"I am definitely not an ardent supporter of the single buyer," he said, "despite being an engineer in my roots. Engineers usually like to come up with the most elegant design and that can lead you to things like single buyer, but what we have seen in the last 20 years is what most of the public understand, the benefit of having a diversity of views solving something."

He warns of inevitable unintended consequences. Mighty River already has an alternative plan around reinvestment in its hydro stations if the cashflows that would require are throttled back.

Under the NZED central planning model, nearly every generation investment decision was a bad one, he said, citing Marsden B (built to run on oil but which never generated a single kilowatt hour), the Clyde Dam with its massive over-runs and Huntly, designed to run on coal but which spent most of its life gas-fired.

"I'm old enough to remember the shortages in the 1970s because someone made the wrong decision about what plant to run. Same thing happened in 1992. We actually ran out of electricity," he said.

"That is what has surprised me over my career. To go from a position where you think the smartest brains would work out the best thing to do, to a system where a diversity of thinking has created far better outcomes."

Dr Heffernan sees the single-buyer model as a form of nationalisation. "They say, yes, it is someone else's capital but we will control the outcomes. That's equivalent of having nationalised the industry."

- NZ Herald

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