Dialogue: One big power player can be ruin of us all

By JOHN ROUGHAN

Two months ago, when wholesale electricity prices went through the roof, one man told me precisely what was wrong with the design of the market.

At the time I gave the views of Richard Tweedie no more prominence than others, including Energy Minister Pete Hodgson who was lashing him for suggesting households could see power bills of $500 a month.

Back then the prospect seemed remote. The weather had just turned bitingly cold after a long, dry summer. The hydro lakes were down and Auckland was turning on its heaters. You had to expect a spike in wholesale spot prices. But it would settle down.

If some power retailing companies had gambled on another mild winter and were losing millions at the spot price, well, as Mr Hodgson said, "tough". They could not pass the price on because their competitors had hedged their bets and were still getting power on fixed price contracts.

That was then. Two months on, the spot price is still in the stratosphere and those hedge contracts cannot have much longer to run. There is nothing like a $500 power bill to concentrate the mind.

Richard Tweedie is managing director of Todd Energy, a relatively small player on the generating and retailing sides of the market. The problem was, he said, that the last supplier into the market can set the price. Here is how it works.

The electricity market is a kind of futures market. It has to be. Electricity is not a product that can be stored. Turn on a light and a power station responds.

Just as in a finance market, electricity buyers and sellers sit at computer screens trading through a pool.

The electricity is sold in half-hour blocks ahead of time. A price is set for every half-hour through the day and night from 250 exit points on the national grid.

When power station owners quote their prices for a half-hour block of electricity, the cheapest offer is obviously accepted first. Then the next cheapest and so on, until the market has all it thinks it will need for that half-hour.

But the price paid for all the power to be dispatched in that period is the price of the last offer accepted. That is fair and sensible when there is an abundance of power, as there is in New Zealand most of the time.

But at moments like these, when hydro resources are depleted, the retailing companies need all the power on offer. That means the most reluctant supplier will get whatever price he wants.

Not only does he get it, all suppliers get it. There is no need for a conspiracy, a cartel, or oligarchical behaviour to fix the price in these circumstances. One desperate or greedy supplier can do it.

There has been no argument about that. Back in June the Energy Minister readily conceded that the big state-owned hydro generator, Meridian Energy, operator of the Waitaki river system, was in the position of "marginal supplier" to the spot market at that time.

The only debate was about Meridian's motives for the prices it was setting. Were the prices a genuine reflection of lake levels, and Meridian simply asking the price it needed to maintain its business at much lower output?

Or was it "gaming" - driving the market excessively high to make windfall profits or to capture a greater share of the retail market by driving out retailers it knew to be exposed to the spot price?

The largest of the retailers, Natural Gas Corporation, which had bought TransAlta's business, lost a fortune last month before selling all its Christchurch customers to Meridian.

This week NGC quit the electricity business entirely, selling its North Island customers to another big state-owned generator, Genesis Energy. Genesis operates the thermal stations that were supposed to kick in for us when hydro levels were low.

"Told you so," say subscribers to the gaming theory.

If they are right there might not be much for consumers to worry about. Once the generating companies have as many of us as they want (as many as they can supply without going to the spot market) the price should come down.

Already Meridian has announced that it will not accept more retail customers for the time being. The Auckland customer market is now effectively divided among Genesis, Contact Energy and Mercury Energy, owned by the third big state-owned generator, Mighty River Power.

Now that the retail market is dominated by the four big generators, there is potentially greater problem. They have every incentive to favour their own retail agencies and refuse to negotiate hedge contracts with others.

Hedge contracts are valuable for the whole system because they can discourage generators from driving the spot price too high. The difference between hedge prices and a higher spot price can be seen as a loss to the generator.

Furthermore, if the integration of generators and retailers takes too much trading off the market, the whole system will lose the ability to transmit conservation signals, even to the limited degree it has done over the past two months.

There are some bogus solutions about. More competition in generation would make no difference when it takes only one to set an excessive spot price. More capacity would make a difference, but it would be wasted investment 99 per cent of the time, the very thing a market is set up to avoid.

Then we hear the retail market was too competitive, which cushioned consumers who should have been saving power. Cushioning consumers from sudden fluctuations in supply and prices is exactly what a competitive retail sector does.

The market is not yet three years old. Its flaws can be fixed. Let's not throw out the baby with the bathwater.