Russell Longuet: Power commission's big chance

COMMENT

Power prices will rise, but with some changes to the way the market is organised they do not have to rise by as much as some think.

A structural change in the energy market is coming.

One of the important problems with the existing market is that it does not work for big industrial power users.

The spot price is far too volatile, fluctuating up to 1000 per cent between half hours.

There is nothing to create any sort of certainty on price paths, which makes it very difficult to estimate the effect of energy cost on investment.

The electricity industry is not making timely decisions for base load and peaking power generation and transmission investment.

There is no liquid and fair financial market for hedges so spot price risk can be mitigated.

When ECNZ was in charge, "peaking stations" were set aside to generate power in times of shortage.

Now that the big "gentailers" (generator/retailers) have in effect become regional monopolies, it is not necessarily in their interests to invest in this "standby power" because they do not know if it will run for 100 or 500 hours a year - and it is easier to let industry shoulder the dry-year risk.

In the old days ECNZ was solely a generator, and despite being a monopoly it did not have a retail base.

It managed resources from a nationwide perspective and the system from a stable, engineering perspective, rather than a totally commercial one.

It was able to put a dampener on the volatile spot prices, because it co-ordinated fuel supplies for least cost to the country.

This is a different motivation from that of the existing SOEs and Contact, which are all trying to maximise their own profits.

One of the jobs of the new Electricity Commission is to create a dry-year risk reserve. The levy that will be imposed on every consumer - the insurance premium - will be spread across the whole economy rather than as happens now, where 10 per cent of the market - the big industrial users - end up clearing the market at a very high price that is paying the dry-year risk premium for the whole country.

The other aspect to consider in the mix is gas. At least 25 per cent of our electricity is generated from gas, which now comes from the declining Maui gasfield.

In future, electricity will be generated with gas from the new Pohokura field at an increased price, which means that all electricity prices will rise.

Electricity is one of the few comparative advantages we have as manufacturers in New Zealand.

We have to contend with numerous disadvantages - we are an export-oriented country, we are a long way from markets, we don't have a big domestic market and we have shipping problems.

It is true that we have had relatively cheap energy, but we needed it to offset all the other disadvantages.

If we lose that comparative advantage, major industrial users will seriously consider where they would build new plant as alternative countries become more attractive.

I don't believe that excessively high power prices need to eventuate.

Obviously we need more natural gas. I'm sure there is gas available - it is just a matter of bringing it to market as quickly and as competitively as we can.

In a very small market where about 75 per cent of the electricity is state owned and the market is not working competitively for consumers, we need limited Government intervention to moderate the imperfections in the system.

The Electricity Commission has the mandate and the potential to achieve what major industrial users need - reduced volatility in the spot market, more pricing certainty, timely decisions on base and peaking stations and transmission investment and the creation of a liquid and fair financial market so spot price risk can be mitigated.

The commission has the mandate and the powers to do all these things and the potential to achieve improvements.

But it could just as easily muck it all up if it doesn't use its powers judiciously and with an understanding of the real issues of consumers, particularly the major industrial consumers and industry.

The commission has the potential to act as a circuit breaker between the big "gentailers" and the consumers, but there is also the risk it will be captured by Government officials.

At this stage there is only a need for limited Government intervention in the form of the commission because the suppliers had not provided what the demand side needed.

The commission, a Crown entity run by independents, has the potential to do something worthwhile.

Used judiciously, a dry-year risk reserve can be used to put something of a natural cap on prices for 97 per cent of the time.

* Russell Longuet is Carter Holt Harvey's energy manager.