Hayden Green: Power play over Rio Tinto's Tiwai aluminium smelter

Pylons carrying the massive electricity supply to the aluminium smelter operated by Rio Tinto at Tiwai. ODT photo / Stephen Jaquiery

COMMENT

Once upon a time, a group of mice gathered to consider how to outwit their common enemy – a marauding cat. It was agreed that the best solution was to place a bell around the cat's neck to chime a warning. There was just one problem: finding a volunteer to affix the bell.

This sixth century fable is perhaps the earliest example – albeit a metaphorical one – of a "collective action" problem: where many would benefit from an action which nobody is prepared to undertake alone. Fast forward 2600-plus years and an analogous dilemma – but this time very real – could soon be confronting electricity generators as they face (again) the prospect of Rio Tinto pulling the plug on the Tiwai Point aluminium smelter.

The loss of the largest customer would see the market awash with surplus power. This would be great news for consumers at a time when energy affordability is at a crisis point, since the surplus supply would mean lower prices. But for generators receiving those reduced prices it would mean lower profits and, for some, costly plant closures – Genesis' ageing Huntly units being obvious candidates. On the day that Rio Tinto's "strategic review" was announced, $2 billion was wiped off the market capitalisation of the big five gentailers.

There consequently seems to be little doubt that investors in the wholesale sector would benefit tremendously from the smelter remaining open. The question is: would it make commercial sense for any one of the big gentailers to provide Tiwai with the cheaper electricity prices it seems to be seeking? That all depends on which scenario returns the most value to shareholders. Is it:

• Continuing to supply the ~620MW that Tiwai needs at a bargain basement price, remembering that the smelter currently pays around one-third of what you and I do for each kilowatt (last year Contact even admitted to taking a $9 million bath on its portion of the deal to supply Tiwai with discounted power); or
• Absorbing the loss in profit caused by the wholesale price drops, additional transmission costs and asset retirements that would occur if Tiwai shut.

Sending electricity to the upper North Island, instead of the smelter, would cost an estimated $600m. ODT photo / Gerard O'Brien

Even if this cost-benefit calculus stacks-up for any one particular generator, it may be reticent to foot the bill on its lonesome. It might ask itself: "why should I dip into my pocket to keep Tiwai open when other generators are clearly benefitting without coughing up a cent?"

So far, no generator has expressed any interest in volunteering to "put the bell on the cat". Quite the opposite, in fact.

Genesis chief executive Marc England has suggested that because his company is a North Island-based generator, it might escape relatively lightly if Tiwai exited and could even benefit commercially. So, count it out.

Meridian's position has also been clear for some time.

When Tiwai's supply contract was renegotiated in 2015, Meridian stated categorically that
the support of other generators was needed to offer a deal that was mutually acceptable. It was unwilling to solve the problem by itself. At the last minute, Contact, Genesis and Mercury stumped up with around 28 per cent (~172MW) of Tiwai's requirements via a series of back-to-back contracts, thereby "sharing the pain".

If no generator is prepared to "go it alone" then, if Tiwai's latest threat is to be taken seriously (a big "if"), any solution would again need to lie in a collective response.

In theory, it might be mutually beneficial for a group of generators to each supply Tiwai with an even cheaper chunk of power – at a modest cost to each firm – in order to avoid the much larger costs they would all face if the smelter closed. However, continuing with our feline theme, arriving at such a solution could be like herding cats.

Even if the various actors were able to meet to discuss the problem, arriving at a solution would be very difficult – especially given the very different ways each generator would be affected by any closure. Who would offer what?

Hayden Green. Photo / supplied

And, of course, competitors could not meet in this way. The Commerce Act prohibits rival firms from entering into a contract, arrangement or understanding to fix, control or maintain a price. This rule exits for obvious reasons: to stop firms from colluding to keep prices artificially high. If competing generators gathered to discuss what to offer Tiwai to keep it in business – thereby "maintaining" wholesale prices at their current levels – it would almost certainly run afoul of this prohibition. In other words, in this case, the mice are not even allowed to meet to discuss their cat problem.

This consequently has all the hallmarks of a classic collective action problem. It is quite conceivable that generators as a collective would love to stop Tiwai from exiting.

However, it is also possible that none is willing to act unilaterally to prevent it and a co-ordinated response may be administratively impractical and perhaps even illegal. That could be very bad news for generators but, on the bright side, it would be good news for their retail customers who would be likely to see their electricity bills fall.

• Hayden Green is a director at Axiom Economics.