Pattrick Smellie: Electricity's real elephant in the room

An elephant in the room is the thing that everyone can see but no one wants to discuss, therefore it is not the threatened closure of the Tiwai Point smelter. Photo / 123RF

COMMENT:

In his last speech at an annual meeting since taking the reins at Contact Energy eight years ago, departing chief executive Dennis Barnes talked about the presence of an "elephant in the room" – the threatened closure of the Tiwai Point aluminium smelter.

That description was not quite right.

An elephant in the room is the thing that everyone can see but no one wants to discuss. There was plenty of discussion about the implications of an early retirement for the country's single largest user of electricity.

What neither Barnes, nor chair Rob McDonald, nor any inquisitive shareholder mentioned was the building pressure among all the electricity generator-retailers to raise the energy component of the power prices paid by retail customers.

This is the real elephant in the room for a sector.

How, when and how much to raise the energy component of householders' electricity is very much on the minds of the big five electricity generator-retailers - Contact, Genesis, Meridian, Mercury and Trustpower – right now.

After a long period during which it was either unnecessary, unjustifiable or impolitic to raise power prices, a combination of factors is converging to force the question now.

The first reason is the sharp upward jump in wholesale electricity prices seen since the beginning of last year after a prolonged period through the middle of this decade where wholesale electricity prices were historically low.

For a while, wholesale prices were low because the electricity sector as a whole over-built new power stations. There was simply a lot more electricity available thanks to a rush of new wind and geothermal generation, which was commissioned in the early 2010s and is now mostly on stream.

The pressure is on to 'adjust' power prices. Photo / 123RF

For four or five years, nothing new was built as electricity demand remained roughly unchanged, despite strong economic growth rates. Energy efficiency investments and reduced demand from major industrial users decoupled electricity demand growth from economic growth for the first time.

Combined with the generation over-build, the scene was set for stable prices.

During this period, courageous new electricity retailers like Flick Electric – which charges variable prices based on the constantly changing wholesale price of power – got established.

They had a measure of success while wholesale electricity prices remained low and stable.

Old industry heads all said the same thing: wait until wholesale prices rise or become volatile. How would Flick and its kind fare when customers who were used to feeling clever for paying a low power price compared to others were exposed to the opposite experience?

Z Energy gave one answer to that just a couple of weeks ago. Having spent $46 million in August 2018 to buy 70 per cent of Flick, Z wrote down the value of that investment to just $11m in its most recent earnings result.

That value loss directly reflects the damage that high and volatile wholesale electricity prices have wreaked on the Flick customer base.

However, there was another major reason why the big power companies were happy to keep a lid on household electricity prices for the last couple of years. That was the government's Electricity Price Review, which has only recently been completed after it was written into the coalition agreement after the 2017 election.

No electricity company in its right mind was going to do anything aggressive to its tariffs while that was going on. Instead, they poured substantial effort into convincing the review panel that the current market arrangements are working well, which is in fact what the review concluded.

With the exception of certain sales and billing tactics, and some technical work to improve the operation of the electricity futures market, the sector got as close to a clean bill of health as it could have hoped for, given the review was originally a populist demand from NZ First.

Now, however, the pressure is on to "adjust" power prices to reflect the fact that wholesale prices are so much higher than the last time there was any significant price change for the bulk of households and businesses.

The only gen-tailer CEO to address the issue publicly so far has been Mercury's Fraser Whineray.

While major industrial users, including the Tiwai Point smelter, are on contracts that expose most to at least some of the recent rise in wholesale power prices, he acknowledged "very real risk in the regulatory space" if those impacts start flowing to households.

Mercury CEO Fraser Whineray. Photo / Supplied

"It could be severe if it's not managed well," Whineray said.

The risk is all the greater if those price rises occur in election year, which makes the next few months a nervous time for the power companies if they're to make tariff adjustments that their shareholders are now starting to demand.

However, there could be an out-clause. The Commerce Commission's new regulated rates of return for monopoly electricity lines networks – who own the wires that the electricity travels down – will kick in next April.

At this stage, most lines companies are expecting they will have to cut their current prices.

Expect the gen-tailers to try and mash those changes together with their energy tariff increases, to produce something that looks far less scary than might otherwise have been the case.