By DR BRENT WHEELER
‘It’s the rain, stupid” has become an increasingly unsatisfying answer for consumers, producers and investors alike as the power crisis has worn on.
Reasonable questions should be posed. such as: “how are we faring”?, “have the reforms of the last decade served us well”?, “should we be making radical changes”?, “what can consumers expect”?, and “what can investors expect”?
Like a good many reforms to the New Zealand economy the advances made through the electricity reforms — lumpy, bumpy and incomplete as they have been in parts — are not properly appreciated by the much vaunted “common sense” person in the street because she/he never knew how bad things were before.
Some bad mistakes were made with this:
Mistake number 1:
Domestic users were told their prices would come down. Wrong. At the time the reform to retail electrical distribution took place there was on average (meaning there were worse cases) a 30% subsidy of domestic use by commercial and industrial users.
The reforms began to strip out this subsidy. The benefits of this could not be seen readily. Large industrial users did not make great gains. In many cases they already had the gains through their economies of scale and existing leverage.
Small and medium enterprises did make some gains. That is critical. Around 80% of the economy is made of these types of business. Their voting voice was and is lost in the screams of justifiably disappointed domestic consumers with dashed expectations over something that couldn’t be delivered.
Mistake number 2:
Domestic users were told switching would be easy. Wrong. Switching was never going to be easy, especially till we learned how, and the tales of woe could fill volumes if David Russell of Consumers Institute cared to write them all up.
Switching is difficult since it involves a large number of people coordinating a great deal of information to tight timeframes in a complex monitoring regime in a situation where mistakes mean either no power or huge bills — and both have been experienced.
There are solutions to this — notably based around processes such as Infolink Ltd’s internet task processing, but even then the systems take time to implement and operate to the required level of supply assurance and financial accuracy. Learning costs and costly switching does not however mean we should not have been switching.
Promising the undeliverable almost always delivers unjustified condemnation. So much for spin-doctors.
Have the Reforms Performed?
The answer to this question has to be “yes”, and “not just yet but they will”.
On the “yes” side, we undoubtedly have competition and some outcomes which were never seen prior to the reform of both the retail side and the very partial privatisation seen in generation.
We have seen Contact Energy shareholders — not taxpayers — bearing risk. We have shareholders not Cabinet Ministers bringing boards to account, complaining about senior management, having strong words about executive remuneration and all on the basis of what an equity market is saying about the company’s performance — not on the basis of a guesses from the bureaucracy’s monitoring agencies.
The case of Trustpower is another example. We see investors not consumers bearing risk, asking questions about corporate activity and seeking ways to turn the fortunes of the company around. Public participants in this process are nowhere to be seen. Monitoring the performance of Meridian’s aggressive customer base acquisitions will be a lot more difficult. The same for Genesis with its excursion into the ASP market and with Mighty River Power’s ventures.
On the “not just yet” side, the retail contracts have a long way to go to deliver good consumer value.
The Consumer Contract
A key issue commentators continue to overlook is that the nature of most retail power contracts remains crude. The contract for householders involves an unspecified quantity of product supplied at an unstated quality for an indeterminate period of time usually with the supplier retaining all the rights in respect of pricing. Where there are choices they have centred around the rather fringe issue of fixed line charges versus variable costs. Crude stuff to say the least.
Telephone network service and appliance retailers have learned, albeit the hard way, that something a lot smarter is called for. The Vodaphone and Telecom rate cards offer the consumer a matrix of call plans with numerous variations.
These plans take account of time of day, frequency of use, week versus weekend use, type of call (text, toll, local international) and how the pricing should match capital costs of the cell phone. There is so much flexibility they have to devise smart ways to find the best fit.
There is even an answer to that. After six months these companies will review the plan and the customers’ usage and switch them to the optimal plan free of charge. They also have “take or pay elements” which is essentially what “free minutes” are.
Contrast that with a retail electricity pricing schedule. Yet from an economic perspective the issues are very similar — as indeed they are in selling network service products throughout the economy. ISP’s and other web related services all boast myriad plans and all are driven by the need to capture and keep consumers.
Note too, that worldwide Telco’s have tried the sledgehammer “purchase at any cost” approach in their prolific use of debt to buy 3 G licences most notably in Europe last year. They paid the price in credit rating downgrades and beaten up share prices and are now scrambling for more orthodox approaches through improving customer services.
There are big lessons here for our electric utility companies. Simply “buying customers” either by capital market transactions as Trustpower did or through offering switching incentives as many did may not be sophisticated enough.
Is there a market response to this — yes but it is arriving only slowly. Some companies (for example Mercury) are offering bonuses for saving energy. One group is seeking to develop a spot market at the retail level. Others will develop in time.
Generational Gains
The gains in sensible decisions about generation capacity have been large. Just recall the massive debate about the “next generation plant” when ECNZ was certain that prices had to increase to cover new generation capacity, and the cost of the next unit was reckoned by the central planners to be around 7 or 8 cents per kwh.
With a much more decentralised and partially privatised approach the figure being debated is closer to 4 or 5 cents per kwh as co-generation plants and options such as refurbishing Manapouri have been uncovered. We have also seen significant innovation — perhaps most evident in Contact Energy’s windmill farmlet in the Manawatu.
Generation assets are long-lived assets. Engineering over-indulgence and gold plating schemes are long-lived liabilities. The more of the latter we avoid the better. So far we do not have another Clyde Dam and with private sector competition and bench-marking of capital budgeting decisions we seem unlikely to.
With the exception of Trustpower NZ, sharemarket analysts all forecast the listed entities involved in generation and distribution will produce increased earnings per share over the next two years. Projected rates of growth vary from 4% — 7%, which is comfortably ahead of consensus forecasts for real GDP growth.
Share prices can therefore be expected to continue to improve.
By and large shareholders have done well out of their utility investments. Taxpayers and consumers have done well out of others, including foreign owners, bearing these risks.
The key risks appear to be the regulatory uncertainty hanging over the gas and electricity industries. In this area moves towards central control and regimes which are uncertain or discretionary undoubtedly pose the biggest risks. Re-working of business plans and corporate re-structuring will also pose some transition risks.
We can expect the hedge markets to operate more to the desires of the participants in the future.
There has been a good deal of learning about the hedging process. Complaints about the “small size” of the New Zealand market do not wash. Markets do not come much more liquid than the New York Stock Exchange — but if you tried to sell shares on the 19th of October 1987 you would have had as much luck as some late to the party electricity hedgers in New Zealand.
Liquidity problems are an inherent characteristic of markets. Before the term “market failure” is used we should ask “compared with what?” Some hedge arrangements have worked admirably. As the players become smarter more will. This seems preferable to relying entirely on the moral suasion of the Minister — good and all as it has proven to be.
Expect to see rapid improvements in the service packages available to consumers. With private companies setting benchmarks, equity markets monitoring their efforts for shareholders and examples of clever pricing in other sectors, consumers can expect more flexible, better deals customised more closely to their needs. Even “smart switching” cannot be far away.
Simple lessons we should have learned:
1. Stand and deliver. Don’t talk up impossible promises then fail to deliver.
2. Learning takes time. Neither consumers nor producers can avoid learning costs.
3. Shareholders are often more effective at disciplining management than Ministers.
4. Pete Hodgson is remarkably persuasive — probably because he has sincerity not spin.
5. We should not fear foreign owners bearing risks.
6. Cell phone power can teach Grey Power a few pricing tricks.
Finally, we do not need radical change especially of the regulatory variety. Unfortunately, boring as it may be, it is partly the rain and the snowmelt, it is partly that change is not a free lunch, it is partly that we are still working on the best ways to exploit the new regimes. All of that is good for consumers, investors, taxpayers and governments. It bodes well for the future.
And of course Rachel Hunter was right — “It won’t happen overnight, but it will happen.”
Power to the People Supplement
Victims filmed in their bathroom say they no longer feel safe in their homes.