Editorial: Careful with that market for electricity

If a war was not commanding so much attention, the subject uppermost on this country's public debate might be, once again, the merits of the electricity market. We are in another period of low rainfall, a looming water shortage, high wholesale electricity prices and already a couple of industries have cut production. This, we suggested here on Monday, is not necessarily a market failure. Powerful figures in the Beehive disagree. After the Cabinet met on Monday the Prime Minister announced yet another inquiry into the electricity trading system, adding: "We are contemplating significant change."

The inquiry will be part of a wider look at infrastructural services, including water and roading, to be led by Finance Minister Michael Cullen. On the subject of electricity supply, Dr Cullen says: "The fact that we have a second dry year in three suggests again that perhaps there is a systemic problem in terms of whether we have sufficient reserve capacity, which is what you might expect to happen with a fully marketised system. I am not happy with that situation continuing."

Electricity is not, in fact, fully "marketised" yet. The industry is dominated by four main generating companies, all carved out of the former state-owned Electricity Corporation, only one of which has been privatised. Dr Cullen's comment suggests that deficiency is unlikely to be fixed. He would agree with lobbyists for major industrial consumers that investment in additional electricity supply is failing to keep pace with growing demand. But he seems to think that underinvestment is "what you might expect in a fully marketised system".

Why would we expect that? Markets have long maintained sufficient investment in the goods and services they supply. We seldom hear of shortages of food, clothing, housing materials, motor vehicles, petrol, finance, furniture, fertiliser and so on. The only services that seem to be chronically inadequate are still largely reliant on state investment - acute hospital care, education, roading and the like. The reason is that those services do not allow prices to ration demand and attract investment in additional capacity.

The electricity market is still in its infancy. It needs to improve its procedures to transmit the fluctuating spot price openly and quickly between generators and wholesale buyers. But it cannot function when politicians talk darkly of intervening in its prices, demand rationing and investment decisions. The first effect of such talk is to put all thoughts of private investment out of mind, as Contact Energy has warned.

Right now the investment outlook is confused anyway, with uncertainty over the replacement of Maui gas and, as we report today, the curious failure of state-owned Genesis Energy, operator of the Huntly thermal station, to forecast its coal requirements this season. The system depends on stations such as Huntly when hydro levels are depleted.

If there is a "systemic problem" in errors such as Genesis has made, it is surely to do with the behaviour of state-owned companies. What private business, observing the dry forecast, would have failed to prepare for an increase in output? With five generating companies now in the trade there should be ample competition to meet demand.

The problem may be that three of the companies have no private shareholders to satisfy and no external check on their investment of profits. One of them, Meridian Energy, is putting nearly $600 million into a hydro project in Australia as well as its plans for another Waitaki River scheme. It has also just opened a second tailrace at Manapouri. The Government and major users might prefer that kind of incremental expansions to keep pace with demand. So might shareholders, if Meridian had any.

Good markets ensure investment is neither too much nor too little. With care, the electricity set-up can get there.