When electricity demand exceeds supply ...

An unusually cold winter and low lake levels are a recipe for bigger power bills. JOHN ROUGHAN investigates the workings of the electricity market.

Is the market working in electricity? Energy Minister Pete Hodgson says yes, because your power bills could soon force you to watch what you use.

But some of those in the business of selling electricity to you say no, because right now the companies that generate power hold all the cards.

After a good long summer and an usually warm, dry autumn, the weather turned very cold a few weeks ago, even in the winterless North.

The combined effect has been to reduce the levels of South Island lakes, which produce most of the country's power, and sharply increase demand, particularly in the cities north of Taupo, where most of the country's electricity is consumed.

For several weeks Auckland has experienced a cold snap more severe than most residents can remember.

Demand has risen to a point where the country is using all the power it is getting from generating stations. That is unusual.

Normally there is excess generating capacity and the owners of the dams and thermal stations have to bid to supply the national grid at auctions held throughout the day. The lowest bid sets the price at which all power is traded for the next slot of time at particular points on the grid.

But when supplies are depleted and the grid needs all the power available, the major generating companies can virtually set their price.

There are suspicions that they may even withhold supply to push the price higher than it need be.

So what has happened to the reserves of thermal-generating capacity that were supposed to get the country through a drought?

After meetings with his officials, Mr Hodgson plainly expected the impact of the wholesale price spike to begin to be felt in household charges.

Last Monday he said the market was working as it should, sending an early price signal that people should avoid wasting power and conserve energy where possible.

By Thursday, before On Energy announced increased domestic rates, he said competition was keeping prices stable at the retail end of the line.

And he delivered a tongue-lashing to "irresponsible" retailers such as Richard Tweedie, managing director of Todd Energy, who said monthly household bills could rise to $500.

Mr Tweedie remains unmoved: "Roughly wholesale prices are five times higher than retail prices at the moment. Your supplier is paying on the wholesale market roughly 20c-25c a kilowatt/hour and charging you on your bill 5c-7c.

"In a normal market that would be passed on to you, and your $100-a-month bill would go to $400 or $500."

Therefore, people would be conserving.

New Zealand, he said, was in a crisis similar to California's, where shortages have driven up wholesale prices, but retail prices are capped and companies are interrupting supply.

Prices here are not capped - and Mr Hodgson vowed last week that they would not be controlled.

But players such as Mr Tweedie say unfair competition from state-owned generators is having the same effect as a retail price cap. The big generators are accused of "gaming" - controlling the supply to drive the price artificially high to make a windfall profit or drive competitors to the wall, or both.

Said Mr Tweedie, "If you had a proper market you would have competition at that lowest point. There would be enough supply out there for other bidders to compete.

"We've got no other bidders. If Meridian did not bid in today we would have blackouts. So Meridian know that whatever their price is, that is the price at which it will be dispatched.

"Where there is not a market working there are massive winners and massive losers. All you are doing is stressing the system. Ultimately, how long can this go on?"

But Meridian may not be the culprit, if the thermal generators are withholding supply.

Whatever the big generators are doing, they are enjoying a seller's market or, more to the point, a wholesaler's market.

The retailing companies that read your meter and send your bills are afraid to pass on the higher prices they are paying, because generating companies such as Meridian also own retail suppliers.

If the big generators have given their retail arm a "hedge" against price fluctuations, those retailers might quickly increase their market share at the expense of those that dare to pass on the rise in the wholesale rate.

"It's nationalisation by stealth," said Mr Tweedie, "because the dominant players are still state-owned generators and the monopoly Transpower. There is no market."

Most in the industry have investments in both generating and retailing, but the balance varies greatly. Companies that generate much more power than their retail customers need are making big money in the cold snap.

But those, such as TrustPower and On Energy, with much bigger retail business, are said to be heavily exposed to the spot market.

Despite talk of a crisis California-style, Todd's electricity offshoot, FreshStart, was not pulling out of the market. Mr Tweedie said: "We are not significantly affected because our generation roughly matches our customer load. We are a bit long on customers but nothing like TrustPower and On Energy, who are hugely long on customers. They will be losing tens of millions a day possibly."

On Energy has asked the Market Surveillance Committee, which operates by rules agreed between the traders of electricity, to investigate whether the market is working as it should in this instance.

Mr Hodgson hinted last week that if the committee decided to recommend a split between generation and retailing ends of the industry, the Government would seriously consider that.

But he did not necessarily accept that Meridian or anybody else was gaming.

"I have had quite a lot of advice that there isn't gaming and none that there is," he told Opposition MP Tony Ryall under questioning by Parliament's commerce select committee last week.

National energy spokeswoman Pansy Wong said Meridian had been able to assure its domestic customers it would be able to hold retail prices.

"In view of that assurance, how far is the wholesale price reflecting the actual scarcity rather than putting some players into a better position?" she asked.

Mr Hodgson replied: "Right now, with spot prices high, everyone who must buy more than they sell thinks the market isn't working and everyone who can sell more than they buy thinks that it is."

Meridian was welcome to try to market itself to customers by an assurance it would not put its prices up, he said. "Whether it works or not, I am not sure."

Meridian's opportunity to be "the marginal generator," setting the price most hours of most days, "should disappear in about a week when we get more juice to the system," he said.

He had intervened the previous week to order Transpower, which operates the national grid, to resolve one of the "constraints" in the system.

Pansy Wong said: "When there was a suggestion business might cut production, Meridian and TrustPower indicated there was not too much of a risk because the pricing signal does not reflect the actual situation. So the winner at the end of this long winter could be the Government with dividends from state-owned generators."

Mr Hodgson said: "If it turns out that publicly owned companies are better hedged than the others, then too bad.

"The Government has an interest in making sure the market works as well as possible. Last Friday in a phone call with Transpower I said don't worry about any conference, just go and relieve the constraint. Got 100 extra megawatts into the system."

That, he agreed, was a modest amount. "One hundred megawatts is not big - Huntly runs at 1000. It's a quarter of the Clyde Dam. But it's continuous. We can't run the Clyde Dam continuously at the moment. There is not enough water in it."

He said the country was receiving better price signals now than in the 1992 drought, before the previous Government set up a generating market.

The question now was, "Do you have a competition model or do you go back to implicit political control of price? That is the big issue. The truth is that when you have atomised ECNZ and privatised part of it, you don't have a choice - the competition model must prevail.

"Our job now is to make it work. It isn't working as well as I would like it to. But the competition model is the one we will move forward with. There is no alternative."