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.


  1. " 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."

    Isn't this true of nearly every market? And if people do not shop around you do have to ask why. Is it that they are happy with what they have? Or are the costs of shopping around too high relative to any possible savings? In short, people act rationally so a lack of shopping round may make good sense for those people.

  2. Thanks for the comment, Paul. I agree, there have to be rational explanations for a lack of shopping around, but it's still not at all clear what they are or who to fix it (if it needs fixing). There was quite a bit of discussion about this among attendees when Martin Cave recently talked in Auckland about the low switching rates in the U.K. market. It seemed odd to me, for example, that if there really were $$$ savings to be had from switching, and people are already had pressed to pay their power bills, there were pretty strong incentives to switch, so why weren't they? I may come back to this as it's an important topic and I haven't really sorted out in my head the various consumer-switching findings of the UK, ACCC and MBIE inquiries

    1. That should have been "how" to fix it...

    2. ...and it should have been "hard pressed".


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