Brian Fallow: Power price report test for Govt

The findings are unlikely to end skepticism that electricity prices will continue to increase unchecked. Photo / Simon Baker

How well are we served by the electricity market? How well is it working?

It depends who you ask.

Ask consumers and you are liable to see eyes roll and lips curl.

The electricity sector has been a hotbed of inflation for years. Residential power prices rose by two-thirds between 2000 and 2007 or 5 per cent a year in real terms, according to the Ministry of Economic Development.

If you add commercial and industrial consumption the figures are better but not much.

A generator like Meridian Energy, by contrast, argues that the market is working just fine, thank you very much.

In an unusually dry decade the market has provided timely warning of stress on the hydro lakes, so that thermal generation is cranked up early. It is more expensive but the light stayed on.

And as for the relentless uptrend in wholesale prices, well that just reflects rising long-run marginal costs of new generation.

Investment in new generation capacity has been occurring and at a rate which has more than kept pace with the growth in demand, Meridian says. That is positive for security of supply.

Don't shoot the messenger, in short.

A darker view of the market, however, is liable to emerge from the Commerce Commission.

It has been running an inquiry since 2005 into whether there is abuse of market power in the wholesale electricity market.

The market sets a spot price every half-hour determined by the most expensive power offered into the market that is needed to ensure that demand is met. Generators which offered power at a lower price get the market-clearing price anyway.

But the generators are also retailers with obligations to customers, generally at fixed prices. So whether a high marginal or spot price is good for a power company in any given period will depend on whether it is a net buyer or net seller and what prices it has locked in for its customers.

Since the market clears every half-hour and has been running for more than a decade there is a huge amount of price data to trawl through.

The commission engaged Stanford University economist Professor Frank Wolak to analyse it.

If you allow for those factors which are beyond a generator's control, like the ebb and flow of demand, hydrological conditions in the hydro system and natural gas prices, and look at the price action that is left, does it fit the hypothesis that when a generator has both the ability and the incentive to command a high spot price it will do just that?

It seems it does.

In a draft paper presented to an audience at the Massachusetts Institute of Technology last month, Wolak reported that his work provided "strong evidence that the higher market prices that occur when the four large suppliers have a greater unilateral ability and incentive to exercise market power ... is due to the fact that these suppliers submit higher offer prices in order to raise market prices."

Each of the four large suppliers submits a higher price when it has a higher unilateral ability to exercise market power, he said, and the increases are in an economically significant range of $10 to $20 a megawatt/hour during peak periods of the day.

Wolak concluded that "the ability and incentive of large suppliers to exercise unilateral market power are important determinants of the supply conditions that determine short-term wholesale prices, even after the impact of exogenous factors such as water availability and fossil fuel prices have been taken into account".

So there is at least a prima facie case that the generators are exercising unilateral market power.

What will the Commerce Commission do about it? Will it take the generators to court?

That would take years and cost a fortune, which raises in turn the question whether the Government would stump up the litigation funding. After all three of the five generators are state-owned enterprises.

And the Government may well have a privatisation agenda.

At the very least it has no ideological problems with privatisation. On Monday Prime Minster John Key was comparing the SOE generators with investor-owned Contact and finding them wanting.

But he has said the Government will not sell State-owned enterprises without a fresh electoral mandate to do so, which would push any sale three years into the future.

Of course the Government also promised tax cuts next year and the year after, which it is now pretty clear won't happen.

The same arguments for reneging on tax cuts and suspending contributions to the Cullen Fund - "That was then, this is now, look at how fast Government debt is growing" - might be used to justify privatisation too.

But taking it at its word about timing, a Government looking to sell or sell down its generation assets for top dollar would still be tempted to avoid long and messy litigation about anti-competitive behaviour in the sector.

Alternatively the commission might decide that it is pointless blaming the generators for seeking to maximise their profits. It might decide that such behaviour is inevitable.

In which case the question becomes how to correct it, without throwing the baby out with the bathwater?

The market's defenders can plausibly argue it has been working well in the crucial respects of handling dry years and providing efficient pricing from the standpoint of generation investment.

Whichever way the commission and the Government go, it has never been more important to be able to trust the independence and rigour of the regulatory regime.

But what do we see?

The Commerce Commission's able chair, Paula Rebstock, has been rolled. She did well by the country's consumers; the ferocity of the corporate white-anting she attracted testifies to that.

And now ministerial oversight of the commission has been delegated to Associate Commerce Minister and Act leader Rodney Hide.

These developments are unlikely to dislodge the suspicion that the relentless rise in electricity prices will continue unchecked and that all that will change is where the profits go.