Power shake up - a beginner's guide

The Labour-Green plan to reform the electricity market aims to address rising prices, the fact that low-cost generators get paid the same for electricity as high-cost producers and the large profits hydro dam owners make from a public resource - water.

Labour finance spokesman David Parker says the electricity market lacks sufficient competition and is failing to keep a lid on prices.

One of the key features of what Labour and the Greens are proposing is that NZ Power, the agency they would set up as a single buyer of wholesale power, would pay generators a price which better reflected the cost of production.

At present all generators whose power is used in any given period are paid the same price as the most expensive power used to meet demand during that period.

That means power generated relatively cheaply at a hydro dam will often fetch the same price as power generated using expensive gas as fuel.

Critics such as energy analysts Molly Melhuish and Bryan Leyland argue that the system allows power companies to "game" the market. For example, they could hold back generation from a large, cheap-to-run hydro power station so that more expensive gas-fired generation is required to meet demand, thereby increasing prices for all the power supplied during that period.

Others point out that New Zealand's major power companies, Meridian Energy, Mighty River Power, Genesis Power, Contact and Trustpower, are both retailers and generators, so that any large profits they make on the generation side may be offset by high prices their retail operations pay for power.

In 2009, United States academic Frank Wolak found that from 2001 to 2007, the four large generators used their market power to push wholesale prices well above what they would have been in competitive conditions, to the tune of $4.3 billion over that period.

Mr Parker says the current model has led to huge profits from holders of hydro power stations which use water - a public resource - as fuel.

"The value of that has been captured by the generators and capitalised into their revalued balance sheets."

Labour and the Greens' solution is NZ Power's "differential" pricing model, where generators would receive payment based on operating costs and a "fair" return on capital.

NZ Power would still operate a bid system where generators competed to supply power but it would have the authority to order generators to use certain power stations, removing their ability to maximise short-term profits by withholding low-cost generation.

NZ Power would on-sell power to retailers and large industrial users at a price based on the average it paid to generators, with the savings passed on to consumers.