Wednesday, 7 November 2018

Two sides to the story

You might think the ugly process of nominating US Supreme Court judges and the predictably  5 - 4 conservative/liberal votes in many of the Court's decisions wouldn't matter a hoot to us humble toilers in the vineyard of New Zealand competition and regulation. But you'd be wrong.

The US Supreme Court, in the Amex case, said something important in June about two-sided markets: formally it's Ohio. v American Express Co. and even has its own Wikipedia entry if you'd like a quick recap of what went on. Two-sided and multiple-sided markets and platforms are everywhere these days - I'm writing this post on one - and even if US jurisprudence doesn't always get a lot of traction in our Anglosphere courts, sooner or later the latest American anti-trust thinking tends to find its way through to us too, not least because the same economic experts front up here.

So Amex is relevant to us, and indeed we've traversed this territory ourselves in the past. I was involved at the time, so I'll just refer to the public material on the credit cards 'interchange case' of 2006-09, where an agreed settlement was reached pretty much on the steps of the High Court (the announcement of the Commerce Commission's proceedings in 2006 is here, one of the settlement announcements in 2009 is here)

This latest US case was about whether credit card companies can include 'anti steering' provisions in their contracts with retailers. 'Anti steering' means that a retailer, if it's signed up with Amex, say, can't nudge ('steer') the Amex-card-using shopper to some other means of payment. The retailer will be wont to steer the shopper to use the card system that costs the retailer least. That's usually not Amex: it charges relatively high fees to retailers to fund a relatively generous rewards programme for its cardholders.

Amex would argue that its card brought its (typically higher spending, upmarket) customer into the shop in the first place, and that at least one of the thoughts going through the buyer's mind when they spend up big in the store is the payoff from the Amex rewards programme. It's a swizz, on this reasoning, for the retailer to benefit from the Amex-initiated deal but put it through the till on someone else's card network.

Before reading Amex, I had sympathised with the plaintiffs (the Feds and 17 American states initially, but down to just 11 states at the Supreme Court). Language along the lines of "you mustn't mention there are competing alternatives to this card" doesn't sound good at all, and both Visa and MasterCard had agreed to stop doing it, with only Amex ploughing on all the way through the American courts. My first instincts would have been along the lines of the minority in the Supreme Court, which said
If American Express’ merchant fees are so high that merchants successfully induce their customers to use other cards, American Express can remedy that problem by lowering those fees or by spending more on cardholder rewards so that cardholders decline such requests. What it may not do is demand contractual protection from price competition (p26)
But to my considerable surprise (I didn't ever expect to find myself agreeing with the conservative majority of the current Supreme Court) the 5 - 4 decision in favour of Amex looked the right call.

The majority found that the credit card market is a two-sided market, which you would think is beyond much doubt. The District Court first hearing the Amex case had, however, oddly found separate single markets for retailer and shopper card services. The District Court got put right by the US Court of Appeal, and the Supreme Court affirmed it.

Following on from that market definition, the majority in Amex said that you mustn't draw anti-competitive conclusions from looking at high prices on one side of a two-sided market, a conclusion which is now a commonplace in competition economics but doesn't seem to have been considered by the Supreme Court before (the minority referred to a case from 1953, but that was long before the modern theory of two-sided markets):
Evidence of a price increase on one side of a two-sided transaction platform cannot by itself demonstrate an anticompetitive exercise of market power. To demonstrate anticompetitive effects on the two-sided credit-card market as a whole, the plaintiffs must prove that Amex’s antisteering provisions increased the cost of credit-card transactions above a competitive level, reduced the number of credit-card transactions, or otherwise stifled competition in the credit-card market ... They failed to do so (pp15-6)
The Amex majority pointed to a variety of evidence that showed no anti-competitive detriment: for example
the evidence that does exist cuts against the plaintiffs’ view that Amex’s antisteering provisions are the cause of any increases in merchant fees. Visa and MasterCard’s merchant fees have continued to increase, even at merchant locations where Amex is not accepted and, thus, Amex’s antisteering provisions do not apply ... This suggests that the cause of increased merchant fees is not Amex’s antisteering provisions, but rather increased competition for cardholders and a corresponding market wide adjustment in the relative price charged to merchants (pp16-7)
and they also cited a wide variety of other evidence (on pp18-9) showing ongoing vigorous competition between the card networks, which made the plaintiff's claim of harm rather difficult to sustain.

They also dealt to the "inherently anticompetitive" argument which I would have been attracted to - that it is inherently wrong to forbid retailers to mention the competition. Amex said that the anti-swizz justification ("you can't welcome our customer and then do a switcheroo against us") was okay, or in the majority's words
there is nothing inherently anticompetitive about Amex’s antisteering provisions. These agreements actually stem negative externalities in the credit-card market and promote interbrand competition ... This externality endangers the viability of the entire Amex network. And it undermines the investments that Amex has made to encourage increased cardholder spending, which discourages investments in rewards and ultimately harms both cardholders and merchants (p19)
If you're still sceptical about ultimately harming cardholders, it helps to think of Amex as an agent aggregating the collective purchasing power of its well-heeled membership to wrest what is effectively a larger discount from retailers.

The minority saw things completely differently, but struggled with their arguments. They persisted with the manifestly uphill notion that there are two separate markets:
the relationship between merchant-related card services and shopper-related card services is primarily that of complements, not substitutes (p11)
Since only substitutes are in the same market, there must must be two markets:
there is no justification for treating shopper-related services and merchant-related services as if they were part of a single market, at least not at step 1 of the "rule of reason" (p12)
The reference to "step 1" is to the 3-step process American jurisprudence follows (plaintiff says anti-competitive harm, defendant can rebut as pro-competitive, plaintiff can respond that it could be achieved less intrusively).

In any event, as a market definition, this looks a somewhat contrived description of what the majority better characterised as two sides of a single transaction. The minority also argued (which they needed to, since their first line of attack was weak), that market definition didn't matter, since evidence of higher prices was enough to establish anti-competitive effect:
The District Court’s findings of actual anticompetitive harm from the nondiscrimination provisions thus showed that, whatever the relevant market might be, American Express had enough power in that market to cause that harm. There is no reason to require a separate showing of market definition and market power under such circumstances. And so the majority’s extensive discussion of market definition is legally unnecessary (p14)
Not convincing at all: if a price increase is sufficient evidence of market power, every business in the country would be in the dock. But when a judgement opens with wrap-me-in-the-flag huffing ("For more than 120 years, the American economy has prospered by charting a middle path between pure laissez-faire and state capitalism") it's a good bet that wrap-me-in-the-logic is in short supply.

The judgment was met with outrage in some quarters. A piece from the Brookings Center on Regulation and Markets reacted with "Why the Supreme Court’s decision in Ohio v. AmEx will fatten the wealthy’s wallet (at the expense of the middle class)", for example, and the Open Markets Institute's Lina Khan wrote on Vox that "The Supreme Court just quietly gutted antitrust law".

I can understand the sentiment: 'anti steering' had initially looked wrong to me, too. But this is now the second time for me in recent months where something that initially looked deeply suspicious from a pro-competition point of view was judged okay (the other one was the Australian Pfizer case). For me, both cases correctly avoided a Type 1 error (wrongly finding anti-competitive detriment). But I'd also accept that in dynamic industries like pharma (Pfizer) and platforms (Amex) the safe path between Type 1 and Type 2 errors is getting harder and harder to spot.

Thursday, 11 October 2018

I've tried to stop...

...writing any more posts about market studies, but events have intervened. The government announced that it's going to fast track the Commerce Amendment Bill, which will give the Commerce Commission the powers to do studies, and also that the first one will be an inquiry into the petrol industry (which was always on the cards anyway).

So I headed smartly to the Transport and Infrastructure Select Committee's website to see where the Bill had got to, and found its final report (published on September 12). Market studies - or "competition studies" as we've elected to call them - have got the tick, though the Committee members divided on party lines on who should be allowed to initiate them. The majority backed either a Minister or the Commission (I'm with them), in line with MBIE's advice in its advisory report on the bill. The National members would have let the Commission initiate only with ministerial approval.

The Committee also went with another good MBIE recommendation. The Committee said (p3):
We consider that it would be appropriate for the legislation to require a government response to the final report. We do not consider it necessary to specify a time frame or process for the response. We recommend inserting new section 51E to require the Minister to respond to the commission’s final report on a competition study within a reasonable time frame.
I was really pleased about this. Of the 15 market studies submitters on the Bill (6 for, 6 broadly neutral, 3 against), only two folks had pushed for it - ASB Bank (submission here, the Ministerial response bit is on p7) and me (ditto, pp18-19). But MBIE thankfully saw enough merit in the idea to run with it. To my mind, it made no sense to set up a studies regime but not address the risk that they would be ignored.

There is also a useful focus (again following MBIE's sound advice) on following up what actually happens after the studies come out. As the Committee put it (p3)
We would like to see evaluations carried out to assess the effectiveness of each study and of the regime as a whole. We do not propose any legislative amendment in this regard. However, we suggest that, as part of the commission’s accountability arrangements with the responsible Minister, one of its performance measures should be to evaluate each competition study and report the results in its annual report.
I also learned from para 20 of MBIE's report to the Committee that "Cabinet has directed MBIE to carry out an evaluation of the competition studies regime after it has been in operation for five years". That's good practice. As I mentioned in a telco context ('Regulation done right'), it's easy to set up regulatory regimes and processes, and then forget to go back and check whether they've done any good or are still needed.

It's a pity in a way that it needed soaring petrol prices to be the catalyst that propelled competition studies up the legislative queue: they deserved a faster track than they'd got up to now. But that's realpolitik, and there's no point being naïve about it. If it took politicians' squirming to get a faster result, let's bank it and get the Commission underway that much quicker.

At the petrol pump

You don't - for good reason - get much of a chance to quote reams of facts on the radio. So for those of you who were listening to my stint on the National programme's 'The Panel with Jim Mora' on Tuesday, here are the numbers on what's driven the rise in petrol prices this year.

Conclusion - roughly two-thirds of the rise is down to the increased cost of the imported fuel, which has been hit by both a markedly higher world price in US dollars, and a markedly lower New Zealand dollar against the US dollar. It's not down to a big rise in petrol companies' margins, which is the story being used to frighten the children.

Most of the rest is down to taxes, by the way, and even more so in Auckland. The numbers above come from MBIE's weekly petrol price monitoring which as MBIE says "assumes retail petrol price are uniform nationally. Auckland City has recently introduced a regional fuel tax that will increase fuel prices in the Auckland region. Our currently methodology does not accommodate regional prices or regional fuel taxes. We are developing a new methodology ... that will include regional retail price differences". Aucklanders can add 11.5 cents to the increase in taxes, meaning that, for them, tax increases have been of the same order of importance as higher import costs.

The MBIE data are a great resource if you'd like to keep tracking developments for yourself. There was also an excellent explainer on the Newsroom website from Bernard Hickey, 'Q+A: Are petrol retailers profiteering?' which provides a lot of useful background.

Tuesday, 2 October 2018

A good follow-up

The New Zealand Institute of Economic Research has followed up on an idea I threw out here in August, suggesting that somebody ought to ask New Zealand businesses exactly what was bugging them when they reported low levels of business confidence (and thanks for the credit in the latest Quarterly Survey of Business Opinion, guys, it's appreciated).

Here are the answers to the special question the NZIER included this time round.

While it's good to know more precisely what's on businesses' minds, in the event it's not hugely surprising. Most people had suspected that businesses were not enormously enamoured of various current economic policies, and sure enough government policy topped the list. The tightness of labour markets (staff availability, wage pressures) and its impact on profitability, are also right up there, as is profitability more generally.

As NZIER said in the media release, "Profitability continued to worsen, reflecting intensifying cost pressures for many businesses. Businesses remained pessimistic about an improvement in profitability", and the overall results in the QSBO were downbeat. Looking just at the "own activity" results, which track GDP pretty well, "Firms’ own activity for the September quarter and expectations for the next quarter both fell, indicating a slowing in economic growth over the second half of 2018".

Hopefully the support from still very supportive fiscal and monetary policy will carry us through whatever slowdown occurs in coming months: in particular, the lower Kiwi dollar has tilted overall monetary conditions in businesses' favour, even as the RBNZ has stood pat on already low interest rates. And let's trust that the long-running  post-GFC global business expansion will not blow a gasket, despite the best efforts of American tomfoolery to derail it.

That's the upbeat take. But if there's one thing that would give you special pause for thought, it's "consumer confidence" turning up in the graph above as businesses' third most pressing worry. I didn't expect it to rate so highly, but looking at it now, I can see why it's there. I'd finger the petrol price as one big factor: here in Auckland the regional tax, the general rise in fuel excise, the high world price of oil, and the weaker Kiwi dollar have resulted in a litre of 91 costing $2.35 - $2.40, and households aren't in a great place to absorb a thumping great whack like that. I also suspect that housing wealth effects, again maybe more in Auckland than elsewhere, have stalled or even reversed.

So the state of consumer confidence is something I'll be watching a bit more closely. Hopefully rising wages in a tight labour market will alleviate some of the budget pressures from the petrol station forecourt, and the September QSBO result of no rise in employment likely reflected firms' inability to find scarce labour, rather than any cutback in hiring intentions, which remain positive. I certainly wouldn't want to see any job insecurity thrown into the already fragile household mix.

Monday, 1 October 2018

What do devaluations achieve?

Perhaps unwisely, over the week-end I queried a bit of logic I saw on Twitter which had argued that a lower domestic currency makes a trade deficit worse.

The reply that came back to my query said that a lower dollar makes imports more expensive, QED.

And although I tried to point out that other things start happening, too, to my surprise I got further pushback in support of the the lower-dollar-makes-a-deficit-worse theory.

Maybe it's a generational thing. Back when I was starting out in economics, exchange rates were typically fixed or managed, currency changes were an actively deployed policy tactic, and the conventional thinking was that you reached for a devaluation to improve your trade deficit.  These days, exchange rates typically float, and the effects of devaluation as an option have, maybe, been forgotten about.

So here's a numerical example of what I always thought was the orthodox way of looking at it. It starts with New Zealand running a small trade deficit - our export revenue from wine doesn't quite match our import bill for oil - and it traces what happens when the New Zealand dollar drops against the US dollar. For dramatic effect I've made it a big fall, from parity with the US dollar to only 50 US cents.

The first panel is the starting point. The second panel shows the immediate impact of the fall in the Kiwi dollar. As the people on Twitter rightly feel, the first impact is of course to make imports more expensive, and the trade deficit does indeed get worse. What we're seeing at that point is the downward, or worsening, part of what used to be called the 'J curve' effect, and these days would probably be called a 'hockey stick' or 'Nike swoosh' effect - things get worse before they get better.

If that's all that the Twitter people were saying, fair enough, though I get the clear feeling that they also believe that the lower dollar will lead to a permanent worsening of the deficit, and that things won't actually get better later on.

But get better, they do, thanks to two responses to the lower dollar.

Panel three shows adjustment on the import side. Oil used to cost NZ$60; now it costs NZ$120. That's a powerful incentive to use less of it - by car pooling, by trading down to smaller car engines, by putting in solar panels, by using more energy-efficient public transport, whatever.

One respondent on Twitter argued that "How do you propose we "cut back" on imports without local industry to meet the demand? Should we just tell people to have less goods and medicines because they've become more expensive?". Well, the answer to that is that people routinely change their patterns of consumption to big price changes. If tickets to the big match get too pricey, you do something else for the weekend. If avocados are $7 each (as they were), you don't make guacamole. But I'll come back to that behavioural response at the end.

In panel three I've assumed that a variety of energy-saving measures in response to much more expensive oil lead to a reduction in demand from 400 barrels to 300. And we saw precisely that response in the real world to successive jack-ups in prices by OPEC, though it took quite a while for people to reorganise their affairs (eg by junking gas guzzlers and designing more fuel-effective engines).

That alone starts to eat into the initially higher trade deficit, which comes down from NZ$28,000 to NZ$16,000. The exact numbers don't matter: what does matter is that we've started going up the swoosh.

But there's also a response on the export side, which I've shown in the bottom panel. Before, the American buyer of our wine was paying US$200 a case. After the devaluation, he's only paying US$100 - it's a complete steal. He could well increase his order significantly - if he was profitably shifting New Zealand wine at US$200 a case, he'll have them flying off the shelves at US$100.

Or it's possible that the winemakers will raise their prices a bit. In the panel I've assumed they raised the Kiwi dollar price from NZ$200 to NZ$250, which for the US buyer means he's still paying a lot less (US$125) than the US$200 he used to pay. I've assumed that there's a mixture of more wine sold, as they are now a lot cheaper in US$ for US buyers, and a somewhat higher NZ$ price.

And hey presto, the overall outcome after both imports and exports have adjusted is a small trade surplus.

"Hey presto" may get you thinking this is all a sleight of hand, and indeed there is an assumption in the background here that those behavioural responses actually happen, and happen strongly enough, to turn things round. And there's a bit of economics (the 'Marshall-Lerner condition') that's figured out exactly how strong those responses need to be.

If you're what used to be called an 'elasticity pessimist', you don't believe the responses will in fact be large, and maybe that's where my Twitter correspondents are. Maybe, on the import side, we're always going to have to buy those medicines, and we can't skimp; maybe, on the export side, some wowser wine-shunning import monopoly won't order more cases then it used to. There's nothing logically wrong with that line of thinking, and at the end of the day the actual effect will turn on the size of the responses. Me - I'm more of an elasticity optimist, and especially over the longer run.

Before leaving what will be ancient history for some and the bleeding obvious for others, I'd just add that back in the day I was never a great fan of devaluations as a policy option. Can they improve the trade deficit? Yes, over time. But should you go there?

Mostly no. Devaluations can come with unpleasant side effects, including the ever-higher-inflation ever-lower-dollar spiral that New Zealand actually fell into. They can degenerate into tit for tat zero sum games (everybody can't simultaneously devalue against everyone else). And they encourage - or at the very least perpetuate - the idea that price is the best way to compete in world markets. So, at most devaluation makes an expedient policy tactic, but it's a poor economic strategy.

Thursday, 27 September 2018

As expected

The NZME/Fairfax Court of Appeal judgement is out and contained few surprises.

The Court had been widely anticipated to rebuff the appeal against the Commerce Commission's refusal to authorise the proposed merger of NZME (the Herald, radio stations, and a herd of other North Island media businesses) and Fairfax (DomPost, Press, S-ST, herd of other media things nationwide). So it did. Rather, the interest was always going to be in what it said about the Commerce Act and how it is supposed to operate.

In particular, was the Commission allowed to count non-economic things in the balancing of benefits and detriments that goes on in a merger authorisation? In this case, the big non-economic detriment was the social loss of media plurality (a very large share of the take on the news would be in one pair of hands).

There was also a likely degradation of the quality of journalism (due to the merged entity laying off journalists) which was also treated as a non-economic detriment. That always seemed odd to me, as a loss of product quality is easily accommodated within the usual economic framework. But never mind: what did the Court say?

It said, count all benefits, count all detriments, whether occurring in the markets affected or not, and whether economic or not. Completely sensible. Key bits (footnotes omitted here and later):
[69] ... The High Court held that the Commission has jurisdiction to consider a loss of plurality resulting from the transaction. It accepted that out of market considerations may seldom arise and the Commission may be susceptible to challenge on the merits if it takes them into account, but as a matter of construction Parliament cannot have intended to exclude such considerations where a proposed transaction is likely to cause them. We agree generally with these conclusions ...
[71] ... Section 3A further presumes that efficiency gains may benefit the public and prescribes that regard must be had to them when assessing public benefit. But as a matter of construction the Act treats efficiency as a subset of public benefit; put another way, efficiency is a mandatory consideration but others are not excluded. To paraphrase AMPS-A (HC), efficiency matters but it does not exhaust society’s interest in the  transaction ...
 [73] ... the Act is not exclusively concerned with efficiency but rather allows it to be balanced alongside other public benefits that may include anything of importance to the community as a whole. Nothing in the legislation requires that public detriments be defined less comprehensively. The identification and weighting of public benefits, including efficiency gains, and detriments is left to the Commission’s judgement.
Perhaps sarcastically, along the way the Court said at [61] that the Commission must have been doing it wrong all these years when it had already been counting a whole bunch of non-economic consequences - "reduced pollution, health benefits of breastfeeding, safer handling of hazardous substances, reduced stigma for psychiatric patients, and social effects of plant closures".

There was one interesting thing in the part of the judgement dealing with balancing benefits and detriments. While it may be tempting, for the Commission or for the merger parties, to chuck in low probability outcomes with high impact - "cure for cancer", "world peace", "Armageddon", you get the idea - you can't do that. As the Appeal Court said (rapping the High Court's knuckles, though otherwise affirming where the High Court had got to):
[92] In our opinion the High Court erred to the extent that it took into account what it considered a remote risk that a single owner would exploit the merged entity for political purposes. We agree that even a remote risk of this kind is a matter of public concern. Post-transaction, NZME’s substantial presence in relevant markets would create a vulnerability that ought to worry policymakers. But unless the risk is thought “likely” it should not enter the balance ...
Had the Commission and the High Court got the facts wrong? No.
[134] We consider that quality and plurality detriments are very likely to result from the transaction. We have examined quality effects first ...We agree with the High Court that quality detriments are very likely and substantial. We consider that they are sufficient in themselves to outweigh the transaction’s benefits.
[135] Additional plurality losses are also very likely and substantial. We agree with the High Court and the Commission that plurality is a characteristic of media markets that is vitally important to the community. We also agree with the High Court that the loss of plurality attributable to the transaction would very likely be irreparable ...
[137] In the result, we find that detriments clearly outweigh benefits, and not by a small margin. It follows that authorisation was properly declined 
My overall take? The jurisprudence has landed in a good place. If a merger has a mix of good and bad stuff, it may get messy: as the judgement says at [80], "We accept that non-economic detriments may complicate merger analysis and introduce an additional element of unpredictability, which is undesirable". But that's the way it is: "Some measure of uncertainty is inherent in the legislative decision to permit authorisation on widely-defined public benefit grounds ... Parliament made efficiencies a mandatory consideration but it did not exclude others or say anything about the weight to be assigned to them".

So count them all (excluding the unlikely ones) best you can, and balance them. That aligns economics, the law, and common sense. Not a bad day's work by the Court at all.

Wednesday, 26 September 2018

We take the plunge...

...and in the interests of scientific inquiry our household has a go at changing electricity retailers.

Time, in short, to stop being the competition equivalent of an unmarried marriage counsellor, and actually use the tools available to increase competition in electricity retailing.

We haven't been averse to switching in the past, but I'd got disillusioned by the first wave of retail competition. The phone would go - it was usually telephone marketing then - and we'd get an offer. Of sorts: a lower fixed daily rate but a higher cents per unit usage rate, or a lower cents per unit usage rate and a higher fixed daily rate. No offer at that time was unambiguously better than your incumbent's tariff, with lower fixed and lower usage rates. You were reduced to getting out a calculator and figuring out whether you'd actually be better off.

So we ended up in the large number of people who didn't switch - somewhere between 400,000 to 750,000 households, according to our recent Electricity Price Review - and helped provide a captive base for the retailers to exploit. As this graph from the Review shows, the gap between the best and worst price plan, and the gap between the best plan and the incumbent's in a a particular area, have been widening, suggesting (Review, p38) that "those consumers who don’t or can’t easily shop around are paying more and more than they need to".

It's been a bit of a mystery - in the UK, in Australia, here - why consumers just sit there and apparently let themselves be exploited. You can't - and shouldn't - ever rule out the possibility that their decisions are entirely rational: when a lot of people do something, there tends to be a reason. But equally the conventional wisdom is more down the lines of low switching reflecting some form of problem in the switching market.

So I set out, with our sample of one, to see if I could figure out what it might be.

I went for Consumer's Powerswitch though I could as easily have used the Electricity Authority's What's My Number. It went easily enough, though I discovered two little wrinkles.

One was that our incumbent - who I'll call Oldco - didn't make it obvious what pricing plan we were currently on (unlike our broadband or mobile suppliers, who do). I figured it out from the wording of the charge for unit usage, and by matching our charges (after grossing up for GST) with those shown (GST inclusive) in the drop-down menu of Oldco pricing plans that appears on Powerswitch.

The other was that Oldco didn't show annual electricity consumption, which you need to get the best plan for you. Powerswitch says that your retailer will tell you if you ask, but it isn't volunteered (or not anywhere I could find on the bill or using Oldco's online app). You can however add up your last twelve months' bills manually, so I did (a little over 9,000 kWh).

Powerswitch came up with a wide range of competitive alternatives, with annual savings of around $500 to $600, or roughly 20%. Well worth having, so I pressed the 'Switch' button and signed up with Newco.

And it's at that point that I unearthed at least one of the reasons for consumer reluctance to switch. Putting aside the associated free and frank discussion on lack of intra-household consultation, what most concerned my better half was, "what if something goes wrong?"  (in our case enlivened by recollection of a previous attempt to change broadband supplier, which had gone phut). This is (I gather from para 9.210 on p504 of the UK electricity review) quite a common fear, though higher among those who haven't switched than among those who've actually given it a go:
We agree with the views expressed by some parties that the perception of problems by those who had not attempted to switch appears to be somewhat greater than the experience of problems by those who had. In contrast to the experience of those who shopped around or switched, 66% of those who did not shop around or switch in the last three years agreed that ‘switching is a hassle I do not have time for’ (compared with 40% of those who had shopped around or switched in the last three years) and 57% agreed ‘I worry things will go wrong if I switch’ (compared with 37% of those who had shopped around or switched in the last three years).
In the end the spirit of pro-competitive market discipline prevailed over fears of a cock-up, and Newco got the tick.

When Newco contacted us, they said that "During this process you may get a call from the previous power company", and rather disarmingly added, "that’s what we’d do". And Oldco indeed e-mailed us, offering a cash rebate, a bigger prompt payment discount, a two-year price guarantee (which was also part of the Newco offer), and - belatedly - the offer of a better pricing plan (with an element of lock-in for two years).

No deal. We're gone to Newco. Some critical mass of people need to follow through on switching, or the system won't work. And - accepting that our own inertia let them get away with it - we're not feeling especially charitable to Oldco. A short term profit focus may well lead the Oldcos of this world to offer poor default plans, anticipating (often correctly) that you won't jib. But if I were in a corner suite at Oldco and thinking strategically about longer-term customer goodwill and regulatory risks, I think I'd be questioning the wisdom of the old way of running the whelk stall.

Friday, 21 September 2018

We've scrubbed up well

Last week MBIE published the first report of the Electricity Price Review - you can find it and its supporting documents here. If it's all new to you, you might want to start with the 'at a glance' summary. If you'd like an eminently sensible media think piece on the review, try Pattrick Smellie's 'Electricity review a smoking pop-gun'. And if you'd like a pot pourri of select items of interest, read on.

First of all, full marks for plain English. The review said (p3) that "The panel was very conscious of the need to ensure this first report was succinct and easily understood by the public", and it shows. The review team credits Peter Riordan of THINKWRITE - well done, that man. Economics, regulation, public policy analysis in general - all can, and should, be made more lucid than they usually are.

On substance, I especially liked this bit of analysis prepared for the review by Concept Consulting.

The logic here, from p32 of the review, is that
Contract prices that were above costs on a sustained basis would suggest weak competition among generators, and that the entry, or threatened entry, of new generators was not restraining prices. On the other hand, prices that were well below costs on a sustained basis would suggest looming problems with reliability of supply because new investment would not be able to keep pace with demand. The comparison suggests competition has been effective in restraining prices. Figure 14 shows how wholesale prices have moved broadly in line with the cost of adding more capacity. Importantly, there is no evidence contract prices have been above costs on a sustained basis in recent years.
That's good to know, because an alternative analysis in the review (pp45-6, with more detail on pp7-8 of the Technical Paper) which attempted to gauge whether the gentailers are earning excessive profits was not convincing. Granted, there were data issues for the review in trying to figure it out. In the end it used a proxy for profits - net cash from operations, ex tax ex interest, adjusted for inflation and the amount of electricity generated -  which showed little change in recent years.

But even if you accept that the proxy is okay, the exercise doesn't answer the 'excessive profits' question at all. Steady net cash flows could mean excessive profits, or, equally, inadequate profits, all the way through. The important question is, what are the profits relative to some measure of the capital employed in the business? That went unanswered.

Something else left a bit up in the air in the review was exactly why the distribution lines businesses went from overcharging business customers to (somewhat) overcharging residential customers for their shares of the distribution costs. There's no arguing about what went on: as the review says (p21), "Shifting costs from businesses to householders was the biggest factor in residential price increases between 1990 and 2018 (a development that began in the early 1980s). During this period, distribution charges for householders rose 548 per cent, while those for commercial and some industrial businesses fell 58 per cent", and here's the graph if you prefer graphs. But, why?

Maybe everyone in the electricity game already knows that the re-apportionment of costs was actually a move from a rort on businesses to something more rational (even if it has now overshot a bit the other way). As MBIE's 'Chronology of New Zealand electricity reform' says (p2), "In 1985 local distribution and supply were the responsibility of sixty-one electricity supply authorities (ESAs) - (there were ninety-three [!] in 1945). These were electorally oriented, statutory monopolies. Inefficiency, lack of customer choice and cross-subsidies resulted". But this may no longer be obvious to the reader in the street, and the review could usefully have given a bit more of the historical context against which this subsequent reallocation has occurred.

Before the review came out, I'd speculated that "there's a good chance that we may have made a better go of publicising and facilitating switching [by retail electricity customers from one supplier to another] than either the UK or Australia with initiatives like the Electricity Authority's WhatsMyNumber". In the end the review wasn't able to come to a conclusive answer (partly because it got a big data dump very late in the piece), but it's still possible we're making a better fist of it than others are (p39):
Overall, some stakeholders consider retail competition is stronger here than in Australia and the United Kingdom, based on measures such as switching rates and savings available from switching. However, some stakeholders consider that, like Australia and the United Kingdom, a two-tier retail market is developing, in which those who actively shop around enjoy the benefits of competition, and those who don’t pay higher prices.
There's heaps more interesting stuff in the review, which broadly comes to the conclusion that we're not too shabby at all when it comes to organising our electricity affairs. There are certainly things to work on - make a decision on transmission pricing methodology, figure out how to incorporate more renewables and accommodate all the new solar cell and battery technologies, do something about raising the lines businesses' efficiency, get a better grip on what's behind consumer switching inertia, and dig into why retailers' costs seem to be unusually high - but by international standards we're pretty hot stuff.

You might perhaps feel otherwise if you focussed on the 'energy hardship' issues for poorer households that made the headlines. But to my mind, that's got a lot less to do with allegedly excessive power prices - "New Zealand’s average residential price was in the lower half of all OECD countries in 2016" (review, p23) - and a good deal more to do with our internationally challenged level of absolute income, and with its distribution. The answers to energy hardship - and food, housing, clothing, medical, and educational hardship - lie more in the realm of raising national productivity and operating a more effective tax and welfare system.

And it's not just this review taking an upbeat view of how we're travelling. It went under my radar when it came out first, but the International Energy Agency has been trekking its way through the energy policies of its member countries, and here are some quotes from the executive summary of its 2017 New Zealand review:
New Zealand has an effective energy-only market. It is a world leading example of a well-functioning electricity market [I think they mean the wholesale generation market here], which continues to work effectively ... New Zealand has the highest penetration of geothermal energy and a significant contribution from hydro. Without any direct subsidies or public support, their share in electricity and heat supply has grown in recent years ... This [renewables] performance is a world-class success story among IEA member countries ... To date, New Zealand’s market design and operation of an energy-constrained system offer a high degree of operational variability, and the system has managed peak and seasonal demand variability successfully for decades. The transmission system operator Transpower is experienced and adept at managing supply and demand adequacy, and the power system demonstrates considerable flexibility and resilience. Other IEA member countries could learn from this experience
We've got a well-established knock-em-down commentariat in New Zealand, and I've done a bit of it myself. So for a change it's nice to be able to say we're doing things a good deal better than your average bear.