A single buyer for electricity?

Last night I went along to the latest evening seminar run by the Law and Economics Association of New Zealand (LEANZ). If you're at all interested in LEANZ's mission in life - "the advancement in New Zealand of the understanding of law and economics" - then it's well worth signing up. It won't break the bank ($75 a year for those in work, $50 for students, $750 for corporates who covers 25 staff). You can find out more at the LEANZ website.

Its main activities are seminars (in both Auckland and Wellington). Last night's was presented in Auckland by Ben Gerritsen of Castalia, on the topic, 'NZ Power: Mainstream or Mad?', 'NZ Power' being the name Labour and the Greens have given to their proposed single buyer of electricity, to replace the current wholesale electricity market. You'll recall this is the proposal that nearly scuppered the Might River Power float, and required the issuing of supplementary information to make it clear to potential investors that there was a material risk to the current power generation regime.

As you can imagine, a lot of people are interested one way or another in the idea, and the seminar was well attended (and thanks to Chapman Tripp for hosting it at their offices).

Ben's main points? First, he looked at why electricity policy changes have reared their head in the first place. The chart below (this and the subsequent ones are from Ben's presentation, which he kindly sent through to me) gives a good idea why, which shows a substantial rise in real electricity prices paid by households over the past 16 years.

One thought I had about this pattern is that it might have been an unwinding of a previous cross-subsidy of electricity to households - we wouldn't have been the only country in the world that arranged affairs to get cheaper power to the voters at the expense of dearer power to industry. I could be wrong: Ben's view was that this may also reflect markets working effectively, in the sense that the more expensive-to-service households end up carrying more of the costs.

Then, after going through the details of the current regime and the proposed changes, Ben looked at whether the NZ Power idea was mainstream, in the sense that it was used by a decent range of other countries. Short answer: no. Brazil is close, and Ontario looks very like the NZ Power idea. That's it. Not that widespread adoption of anything is a guarantee that it's a good idea (look at protectionism) but this isn't a model many other countries have signed up for.

He then went through the various ways in which a single buyer might theoretically work out better than the wholesale market - it might make better investment decisions, it might lower operating costs, it might drive out excess returns, or it might redistribute normal returns (effectively taking the SOE generators' profits and giving them to consumers). None of these looked a goer, and indeed Ben's argument was than neither Brazil nor Ontario had anything good to show for going down this route.
Here's his conclusion on Brazil.

And here's the outcome in Ontario.

Before the presentation, I might have leant towards the view that an oligopolistic generator market might well have been able to sustain excess returns, especially in an environment where barriers to new entry are reasonably high (eg through the laborious consent process). But Ben showed a chart (below) illustrating that various measures of electricity prices (actual contract prices, and measures of what people expected the price to be) actually tracked quite closely to the long-run marginal cost (LRMC) of new generation.

Brent Layton, the chair of the Electricity Authority and the author of the paper ("The Economics of Electricity", available here) that Ben sourced for this graph, also chaired a Ministerial Review of the Performance of the Electricity Market in 2009. He (Brent) concluded from this that "The data very strongly suggests that wholesale prices were accurately reflecting LRMC and led the Ministerial Review to conclude from the data for the period to 2008 “there is no clear evidence of the sustained or long term exercise of market power.""

In sum, for Ben, the NZ Power idea didn't have much going for it.

Next up in the LEANZ seminar series, by the way, is a special event on September 10, 5.15pm for 5.30pm start, at Russell McVeagh's offices on L30 of the Vero Centre, 40 Shortland St, on  the Commerce Commission's new, improved  Mergers and Acquisitions and Authorisation Guidelines, drinks and nibble after. Two great speakers, too - David Blacktop, Principal Counsel, Competition, at the Commission, and Lilla Csorgo, Chief Economist, Competition, also at the Commission. Trust me: these are two very, very capable people who have the law and the economics of the thing nailed. It'll be well worth your while.