Dialogue: Meridian cast as the bad guy in NGC capitulation

By RICHARD BRADDELL

State-owned electricity generator Meridian finds itself playing a new part. Often self-cast as a victim of market manipulation and gaming by competitors, it now finds itself portrayed as the villain that has brought Natural Gas Corporation to its knees, as well as making life uncomfortable for TrustPower.

NGC, from its electricity retailing subsidiary On Energy, is nursing full-year losses of around $300 million, mostly because of its inability to get electricity at reasonable prices to sell on to its customers.

To stem the losses it is selling its 116,000 customers in the South Island to Meridian. The deal seems made in heaven for Meridian, which generates all its power in the South Island and usually has a large surplus of generation over its customer needs. By taking over On Energy's South Island customers, it brings demand closer to its production, meaning that less of its production has to be sold to third parties on the spot market.

But for NGC, capitulation is a bitter pill, and it blames its plight on Meridian limiting its generation and forcing up wholesale electricity prices. In umbrage, NGC has complained to the electricity market's surveillance committee (MSC), which is now investigating.

But why might Meridian want to hold back generation when prices are high? Opinion on this is sharply divided.

The most common view, and one accepted by Energy Minister Pete Hodgson, is that Meridian must ensure there is enough water in the southern lakes to provide electricity to the South Island right through winter.

To Mr Hodgson, the market is simply sending price signals that will encourage people to moderate their consumption, helping to ensure there will be no repeat of 1992, when water heating was cut for up to 17 hours a day and a host of conservation measures introduced.

The case isn't a hard one to make. Meridian is New Zealand's largest electricity generator, accounting for about 30 per cent of production. It is also entirely dependent on hydro production, with two of its lakes, Tekapo and Pukaki, representing 60 per cent of New Zealand's hydro storage. A week ago, the two lakes were only half full and water flows into storage lakes around the country were only 78 per cent of normal.

But at what point does prudence become market manipulation? Meridian chief executive Keith Turner says, with his hand on his heart, that the company is generating no more electricity than it needs to to meet its hedge positions.

Could it safely produce more? Meridian's critics argue that as the marginal producer, only a little bit more could have a big impact on prices. And if Meridian has to constrain its production because of water shortages, that raises an issue of how it will supply 116,000 extra customers.

Part of the answer may be that it has calculated that bringing its customer book more into line with long-term production is worth the short-term losses in taking over On Energy's risk. The takeover also raises a question of whether Meridian will have undue dominance in Christchurch, where it will end up with 90 per cent of the market.

The Commerce Commission is not investigating and competition concerns are not seen as an issue because of the low barriers to entry for competing retailers.

But Christchurch's only other retailer of consequence, TrustPower, has just 15,000 customers. And it has suspended customer acquisition because high wholesale prices are also costing it money. Contact Energy, with about 1000 Christchurch customers, is regarded as unlikely to be interested because its production is balanced by a large customer base in the rest of the South Island.

Nevertheless, Meridian's takeover of On Energy's South Island base was regarded as a question of when, not if, by some observers, given the market structure created when former Energy Minister Max Bradford split the old power companies into lines and energy trading businesses.

Crucially, there was no similar separation between energy trading and generation, and that led to the scramble for customers as state and private generators alike tried to match as much of their generation as they could with secure customer demand. As long as customer demand was in line with production, the generators and retailers could be largely indifferent to the price of electricity on the wholesale spot market.

With the benefit of hindsight, there were three losers in this process: Meridian, which had a large shortfall in customers, TransAlta (now NGC-owned On Energy) had many more customers than it had generation, and TrustPower, which also had a shortfall in generation from which to cover its customer demand.

In each case, they had either to take out hedges which confirm the future prices they buy or sell electricity at, or have large exposures to the unpredictable behaviour of spot electricity prices.

In the past three years, warm, wet winters have ensured plenty of electricity, favouring retailers. That may have underpinned NGC/On Energy's decision to reject what it regarded as unreasonably high hedge prices offered in February/March and go into winter with the demand for its 500,000 retail customers largely unhedged.

The market view is that NGC was amazingly stupid to have taken a bet against the weather by going into the winter unhedged. But NGC managing director John Barton this week defended that move, saying that even if the company had taken all the hedges on offer, it would still have lost money. How much more or less NGC might have lost, he did not reveal. But he did say there were not nearly enough hedges offered to cover NGC's risk. And the prices were very high.

Nevertheless, NGC's woes highlight a lack of transparency in the market, with seller and buyer not always known. The solution, says Mr Barton, is to ring-fence the generators from the retail end of the industry so each player faces a similar risk.

TrustPower goes a step further, suggesting that with three SOE generators fighting among themselves for control of the market, one of them should be sold.

Indeed, On Energy's former owner, TransAlta of Canada, sold out because it failed to gain control of Contact, and so could not secure the natural hedge New Zealand's largest private sector generator could bestow.

But if TrustPower thinks the Government is going to come to the rescue of over-exposed retailers by selling generators, Mr Hodgson has made it plain that it will not oblige.