Dialogue: Why power split would fail

Contact Energy executive DAVID HUNT* puts the case for allowing electricity generators a retail base.

Imagine if small businesses, schools, hospitals and households all over the country had faced spot market prices for power this winter, instead of mainly industrial consumers.

Imagine the outcry from small consumers trying to manage the kinds of risks and judgments that are normally required of only the largest, most sophisticated players in the electricity market.

We had a foretaste of that from the few smaller consumers whose contracts ran out or were cancelled during the winter shortages. But that impact would be multiplied if one of the proposed responses to last winter's problems - preventing electricity generators from owning retail electricity businesses - were to be adopted.

The fact is that allowing electricity companies to strike a balance between electricity output and consumer demand by integrating electricity generators with retail businesses is an efficient, low-cost way of managing spot price risks.

The more certain a generator can be that it has a buyer for its electricity, the more of its production can be committed at fixed prices. When a generator has a direct relationship with retail customers, it gains that certainty and consumers are naturally shielded from spot price volatility.

This was one of the key factors that insulated most electricity consumers from direct exposure to spot prices during the winter, at the same time as price signals from the market produced timely warnings to save power.

Opponents of generator/retailers suggest that enforcing such a split would enhance risk management by spreading the risk more evenly. But the implication of that is that the consumers with the least capacity to manage the risks of the electricity market would be much more likely to end up bearing them.

Leaving aside the likelihood that this would have exacerbated the economic consequences of last winter's shortages, such a proposal ignores the fact that the risks in the New Zealand electricity system have little or nothing to do with ownership, but are embedded in its physical constraints.

We depend on hydro-electricity for between 60 and 70 per cent of our total annual output, but have total hydro storage capacity equalling only two or three months of annual consumption.

In other words, the system is vulnerable to dry weather. This is a fact of life which would not be changed or improved by prohibiting integration of generation and retailing.

Likewise, New Zealand has a long, stringy electricity transmission system and, unlike countries with land borders, we cannot import electricity from elsewhere.

With a relatively small total of power stations, the system is also vulnerable to the loss of major generating plant or supporting equipment.

Again, these risks are at best only peripherally affected by the balance of generation and retail consumer ownership, whereas prohibiting electricity companies from balancing generation and retail assets would remove one of the most effective tools for managing the risks imposed by the physical limitations of the system.

The fact that balanced generator/retailers were best placed to deal with the pressures exerted on major players over the winter months demonstrates their relative stability.

Equally important, if not more so, is the fact that discussion of further major structural change misses the point that security of electricity supply, not industry structure, is the number one issue.

Although a shortage of water was the primary cause of this winter's difficulties, the situation became more difficult because of strong underlying growth in demand.

Between 1997 and last year, New Zealand enjoyed relatively low spot prices from a combination of abundant supply and warm, wet winters. It is becoming clear that the period of abundant supply is rapidly coming to an end. New power stations will be required within three to four years, with investment decisions on new capacity necessary within a year.

The real issues are a pressing need to unblock investment in new generation, to improve the transmission system, and to seek new gas sources urgently, or face the prospect of running out of electricity by the middle of the decade. Anything else risks fiddling while Rome burns.

* David Hunt is general manager, corporate affairs, at Contact Energy.

* Fran O'Sullivan's regular column will return next week.