Dialogue: True rivalry eludes power firms

By JOHN SMALL*

Asking whether the New Zealand electricity industry is competitive is a bit like asking whether people are hardworking: the answer varies depending on where and when you look, and what your standards are.

Some parts of the industry face very weak competitive pressure, and are being monitored by the Commerce Commission to ensure they do not exploit the resulting market power.

These are the lines companies: the state-owned national grid operator Transpower; and the low-voltage local network owners.

There are five other firms of a reasonable size in the core of the electricity industry. This makes it roughly comparable to our banking, petrol and grocery industries, all of which are also essential to our well-being.

While not exactly models of cut-throat competition, these other industries are at least managing to avoid the amount of policy attention being given to electricity.

The reason is that firms in these industries confront each other in most population centres. Even if we would prefer them to be more intense rivals, they at least appear to compete over a larger share of their output than the power companies do.

The power market in New Zealand is quite regionalised, with many local districts having a strictly limited choice of retailer.

There are two reasons for this lack of competition.

The first is that it is expensive to shift power around the country, so generators located closer to the customer base have a natural cost advantage.

The second reason is that generators tend to sell their own power into retail markets. In economic jargon, they are vertically integrated into retailing and have approximately balanced portfolios.

This means that most of the power sold is not traded in wholesale markets.

It is certainly not necessary to structure the industry this way, and there is a real question about whether it is a desirable arrangement for the country as a whole.

Since change is ongoing in this industry, we should think carefully about how a social planner would structure it, if the objective was to make it as competitive as possible.

Suppose the big power companies were forced to choose between retailing and generating. All power would then need to be traded at the wholesale level, with much of this trading being in the form of medium to long-term contracts.

The trading institutions could be arranged with modern electronic procurement models in mind, that is, specifically designed to reduce or eliminate market power.

This would squeeze any economic rents out of the generation sector. It would also make it easier for any retailer to compete in any region.

Some barriers to local competition would remain (diverse use-of-system agreements, volatile transmission charges), but there are ways to reduce these.

If competition is the goal, this approach is at least worthy of serious consideration.

Current indications are that it will not be analysed, however. The industry is self-governed and has enough trouble dealing with proposals on which the members are divided.

A vertical split would make life more difficult for all the power companies and is therefore not likely to be initiated from within the industry.

The Government also appears to have no real appetite for such initiatives.

If this situation persists, the wholesale markets will continue to be something of a sideshow and attention will eventually turn to the problem of how to curtail the market power of regional power monopolies through some form of regulation. At that point, a structural solution that promotes market trading might look very attractive.

* Dr John Small holds a part-time position at the University of Auckland and practises economics through Covec Ltd. These are his personal views.

Dialogue on business

Feature: Electricity

Energy Efficiency and Conservation Authority