A former Energy minister reviews the background to the electricity market and why it is currently at the centre of a political firestorm

By Max Bradford*

It is timely to reflect on the state of the electricity sector as Mighty River Power is prepared by the National Government for minority private sector ownership, and as the Labour and Green parties have announced policies should they become government, to effectively nationalise privately- and publicly-owned companies by controlling their prices and their profits.

NZ First proposes to reacquire the generation companies and create one large state-owned generator like the NZ Electricity Department (NZED) once was.

These are dramatically different approaches.

National believes that the electricity sector works best within a competitive market, with a mix of private and public ownership, and regulation where there is no competition in those parts of the sector where there can be no competition, ie the local lines companies and Transpower.

This is their approach – followed successfully by the rest of the world – to get efficient generation and the lowest power prices possible. Labour, NZ First, and the Greens believe that the only path to efficiency and lower power costs is through state ownership and control.

The country has been there before, when all power was generated and distributed nationally by the NZED, and distributed locally by publicly owned electricity supply authorities (ESAs).

To my knowledge, no other country is proposing re-nationalisation of the electricity sector: moves are clearly in the other direction, to implement competition in electricity markets even in former centrally run economies such as Russia and China.

Some people in New Zealand believe that the electricity sector cannot be competitive, and prices will always be higher than in a state-owned, politically determined industry. This belief is in spite of the fact that all other sectors of the economy once owned by the government (eg telecommunications and airlines) and now operating in a competitive market, are giving consumers choice and often lower prices.

How many people would want the government to monopolise air travel or telecommunications again? Competition has produced results for consumers, and given tax revenue to the government, whereas in the past taxpayers were subsidising these sectors.

Introducing competition into the electricity sector began in 1989 under the fourth Labour government. The reason why this change was pursued was simply because the state-owned and controlled system was failing to deliver security of electricity supply and prices had risen continuously at rates well above inflation.

Comprehensive changes were made in the sector. Local ESAs were encouraged to operate in a “businesslike” manner, whereas many had used their electricity consumers as cash cows for subsidising rates. National transmission was separated from the generation arm of NZED to increase transparency of pricing, but remained in state ownership – as it does today through Transpower.

The most comprehensive change was in the generation sector.

NZED was split into competing generation companies, some owned by the private sector, but the majority – by generation capacity – remained in state ownership. A wholesale market was established where lowest cost electricity was supplied to consumers first.

What happened as a result of these changes?

When competition was introduced in 1998–99, real electricity prices fell on average for four years. This had not happened in the preceding 20–30 years of state ownership and control.

Prices fell more for some consumers than others: the commercial sector, and farming had been subsidising households for years as prices were politically determined, with the result that very high non-household power prices helped make business and farming internationally uncompetitive.

Inflation adjusted prices for local lines distribution companies fell substantially for some years after 1999, as the regulator – the Commerce Commission – forced these monopoly companies to seek cost efficiencies and only allowed a reduced rate of return on capital because of the lower commercial risks they faced compared to competitive companies.

In 2002, the then Labour government began to re-regulate the market in a series of policy moves.

The overall effect was to reduce the competitive pressures on the generators.

Government policies reduced the ability of companies to build low cost thermal generation (such as low emission coal fired stations). There were other pressures as well which no government could avoid, eg the ending of low cost gas supplies from the Maui gas-field, and the addition of increasingly expensive new generation capacity as lower cost alternatives were not available (such as wind power).

The result was a 72% increase in inflation adjusted power prices between 2002 and 2008. This had nothing to do with the market, but was principally the result of Labour’s policy mix where the market could not find the lowest cost generation capacity and the downward pressure on electricity prices of the 1998–99 reforms was eliminated by government policy.

During this time, the government also sought higher dividends from the state-owned power companies, which in turn put upward pressure on prices.

With the change in government in 2008, the policy pressures on competitive pressures were reinstated.

Consumers were encouraged to shop around for alternative electricity suppliers, just as they do for air travel, mobile phones, or petrol, with initiatives like Powershop and greater transparency of pricing.

As a result, power prices have risen at a far slower rate than in the seven previous years. Whether they can or will fall, depends on the policies being followed by the government of the day, and perhaps more importantly on the cost of each new increment of electricity generation capacity as New Zealand has run out of “cheap” renewable energy such as hydro.

As a country we have clearly reached a fork in the road: do we continue to promote competitive measures to force competitive generators to look for lower cost solutions, together with sensible regulation on monopoly parts of the electricity sector; or do we return to the post-war model of monopoly state ownership and control, where political parties determine prices and profits?

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The Hon. Max Bradford was an MP from 1990 to 2002 and was one Minister of Energy who brought competition to the New Zealand electricity markets. This article first appeared in the NZICA Journal, and can be viewed here ». It is here with permission.

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28 Comments

Two statements from the above:
''The result was a 72% increase in inflation adjusted power prices between 2002 and 2008.''
and
''As a result, power prices have risen at a far slower rate than in the seven previous years.''
 
One of them has a data point (72%), the other has an indeterminate 'far slower rate'  comment to support it.
Tell us what the actual data was to support the second comment, we will judge whether it was a 'far slower rate'.
By the way it may not have occurred to this so called 'expert' that the period 2008-till now also coincides with a fall in electricity demand in NZ (but we wont let that little fact get in the way, will we). Something to do with a minor economic inconvenience the globe has suffered, apparently (and a small event in CChurch). In the previous period electricity demand was increasing significantly.

andyh,
Fair questions, and good last summary; although the questions imply you've been partially sucked in by National spinmeisters.
My understanding is that electricity prices have gone up roughly 5% a year since 2008. The 72% increase over 6 years gives a 9% to 10% per annum amount for that period.
Where the spin fails in logic, is that if the rise of 72% was outrageous (and I agree on the face of it, it was); then prices should have come down 5% a year since then, not gone up even further.

Sucked in by National spinmeisters? Yuck, how so? If I am not mistaken the author is an ex-Nat with a very vested interest in painting the Green/Lab plan in the blackest terms. I was seeking to pick holes in his thinking (if thats what it is).
Just as a general comment, is it me, or do we seem to have considerably more articles on this site pushing the Nat line on the proposed electricity changes than articles supporting the Green/Lab changes? The FF mouthpiece has been all over the issue of couple of times, and now this......

andyh,
No offence meant, and I understood you were successfully picking holes in his argument. My only partial criticism was in possibly accepting the thought, put out aggressively by National, that if something has increased outrageously in price to a level that is say 30% overpriced to pick a number; that to only add another 20% on top is somehow an improvement.
On your second point, I actually think the interest.co.nz team have done a very good job on the subject. David Hargreaves, Gareth, and Bernard each have reported comments by material players (and Bradford was the architect of some of the main reforms, which even I accept were well intentioned at the time), often adding their own impartial, or even left leaning comments (in Bernard's case); but more importantly leaving the rest of us to pick the comments to pieces or not. In my view it's fairly entertaining.
Comments from self interest groups supporting the status quo (albeit conveniently forgetting that selling the assets is not the status quo) have been far more numerous, so more likely to get published. 

Greens & Labour have not a snowballs chance in hell of nationalising the electrical power sector. because
1) The government cannot afford to buy the Companies back , its already broke
2) The opportunity cost of nationalising the industry   vs.  building new roads , hosptials clinics  and infrastructure  is too high
3) The cost of borrowing capital internationally to buy the companies will not see a return on investment sufficient to service the debt  from foreign lenders, who will require a premium on such an escapade  
4) The cost of borrowing domestically to nationalise the industry is a zero sum game , you either pay interest to Kiwi lenders or  dividends to Kiwi  Mom and Pop investors.
5) Funding locally will cause a "crowding out effect" making money more expensive
6) Our already weak Capital Market would be gutted and almost cease to exist
7) The damage done to Kiwisaver members and NZ Super recipients ( and thats nealry all of us ) would be enormous  
8) Do  something dumb like nationalising a whole industry and the chance of ever catching up with Australia will simply never happen.

8) Do  something dumb like nationalising a whole industry and the chance of ever catching up with Australia will simply never happen.
 
The "Lucky Country" is no longer enjoying it's taxing authority of others endeavours and has gone broke - were you too busy spouting ideological nonsense to take note. Many have recently made a bonanza trading it's sovereign debt and successfully hedged the proceeds back into KIWI.

Stephen: that sounds complicated .. "sovereign debt" is a compound term is it not .. where do I find some .. when you say "many" are you referring to us "little people"? .. c'mon, dont be coy .. 

"sovereign debt" is a compound term is it not
 
A description

Ah , Stephen , even with Soros taking a punt , and the Aus $ losing a few cents , the Aussies are still the lucky ones and better off than us:

  • A weaker Aus$ will help its exporters
  • Aussies have  50 times the average level of saving of Kiwis through their private superannuations and pensions
  • The ASX is now so much bigger than the NZX , that the entire NXZ capitlaisation is smaller than some indivdual listed counters on the ASX .
  • Aussie Foreign reserves are  massive compared to ours
  • Mining royalties have given them a massive advantage and led to  huge wealth creation for ordinary Aussies
  • Aussies Incomes are higher
  • Aussie Tax brackets are more favourable
  • Their houses and properties are worth more
  • Houses are much cheaper to build  
  • Petrol is cheaper
  • Milk is cheaper
  • Meat is cheaper
  • Bread is cheaper 
  • Fresh vegetables are cheaper
  • Rents as % of income are lower ( except Sydney)
  • Muncipal Rates and taxes are lower than Auckland in most cities
  • They did  get more interest on savings than us , but their cash rate is now the same.
  • ELECTRICITIY IS CHEAPER and many  of their utilities are listed on the ASX already   

And now the two Goons  Russel and David are hell bent on F()c&!#& up any chance of us ever catching up with Aus

I presume you defected and taunt us from a distance.

life is tough in greenhithe

The Lucky Country is 85% coal-fired electricity.  No catching up to be done, we're so far ahead it's not funny; problem is that we in turn are well behind where we need to be.

Hi Boatman

You missed one further reason why Labour and the Greens haven't a chance of nationalising the electricity industry and that is because nationalising is NOT their proposal.

Don't believe everything Key and Joyce say.

There's noticeably no comment from Bradford on the university papers proving the power companies have gamed the system by including a limited amount of very expensive generation into each day's auction (and deliberately not first including all reasonable cheap alternatives), in order to maximise their pricing- given the system allows them to charge for all power at the unit price of the most expensive.
There's similarly no comment on the non entry into the market of significant new standalone generators, or standalone retailers, as they are gamed out of any chance under current regulations.
The industry is largely now nationalised- or at least was until yesterday. Buying them back is an option, and despite what Boatman says above (in parroting Bill English's possibly genuinely believed but now outdated view of how sovereign economies are best run post the GFC), a sovereign nation with an overvalued exchange rate actually has plenty of options. Selling off some of your best assets is the worst of them.
Now we all understand a bit better how the market works- or doesn't in fact work- I have some preference for the Labour Greens approach, than NZF's, although most certainly would not sell further hydro capability off. The Lab Greens approach it seems to me will allow a much more aggressive market approach- not less. 
 

"The Lab Greens approach it seems to me will allow a much more aggressive market approach"
 
Centrally planned, Run by politicians..........is that a Tui I hear?

 
waymad,
Assuming you have been paying attention the last couple of weeks, you will now understand the current market does not work, and is being gamed by corporates. I am a big fan of corporates, in terms of businesses of scale that they can run to our mutual benefit. (and have worked for them directly or indirectly most of my life). I also understand how they will absolutely first of all look after their senior managers and directors if their market circumstances allow, and then their shareholders, with other stakeholders very distant in consideration. Thankfully most industries have sufficient consumer choice and promiscuity that consumers do get considered. 
A non functional market was arguably okay when the benefits flowed back to the state.
Now under the Labour Greens proposal, as I understand it, the government can be somewhere between ruthless (very market oriented) and an active price setter (which you state that you don't like, but you (and I) may prefer to the ruthless approach).
Ruthless to me could look like the following.
All generators, give us your best price for a range of demand over the next year (or two, or three years). Commit to minimums kwh per day, half hour per day, and advise any maximums. Any excuse to not run all your reasonable hydro capacity first will need to be explained in advance. The powerco is not obliged to take any or all of this capacity. Any generator not having a sharp pencil risks missing out on material volume for the year.
Then to retailers; here's the weighted average price (which is the generators' price plus a trivially small margin to run the powerco). You know the price for a year, so can price accordingly. We are happy to sell to any plausible body, and guarantee supply. Telecom?, New World or Countdown; Co-ops like farmers co-ops, plus of course the incumbent gentailers. Sell then to consumers at whatever price you can. 
There are no doubt real complexities around geographies and market mixes, but the principles are simple enough. I have seen this type of market work very well in other industries.

Ya, SH, the ruthless approach could well work. 
 
In theory.
 
What you advance is very similar to the merchandising cubes I useta work on:  plan out shelf by shelf, per week, per product group, per store, per country, per currency, given logistics and supply chain constraints yada yada.  And refresh/update the whole shebang weekly based on feedback from actual sales.
 
What I hold out very little hope of, is the standard Gubmint ineptocracy's chances of gathering enough functioning brain cells, reliably for years on end, in one place, and with some guaranteed continuity of both policy and execution, to build and run such a rig.....
 
For a working example of Gubmint's firepower, see IRD (still stuck in COBOL, ferchrissake) or MSD - beholden to the whims of ideologically certain politicians.....
 
And the fatal flaw in such a set-up is always this.
 
Such models are perfectly buildable and runnable.  But get one assumption, rule, feeder or other component wrong, and the recalculated results are all foobarred.  And it can take the finest minds weeks to figure out the convoluted chains of data dependency.  Such minds are not typically found in Gubmint warrens.
 
Hence the need to build in graceful failure - spread the risks.
 
Which ya does by having many, competing models......

we been ruthless for a good few years now - and maxless too. To my way of thinking, it's been an improvement.              :)

huge...
 

"Such minds are not typically found in Gubmint warrens." nor in private industry...at least not working for the "greater good" as opposed to using their intelect for personal gain while pillaging others no matter the impact.  You can look at the likes of ENROL to see such outcomes. 
regards
 

Sigh.  such a sweeping generalisation.
 
Careful ya don't PO those who toil at growing, distributing, certifying, packaging, retailing and transporting your Food.
 
Every man-jack of 'em in that Awful Beast - Private Industry - "pillaging others no matter the impact".
 
Now just lemme tweak that rule on our forthcoming Central Food Plan cube:
 
CASE when UPPER(CUSTID) = 'STEVEN' then 0
else REQUESTEDFOODQTY end
 
And now tell me that could Never happen under a Gubmint-controlled distribution planning system.....

and your generalisations on Gummit are not so sweeping? 
In terms of food post peak oil the only country that has gone through an enforced peak oil event after the collapse of teh Sovient Union dried up oil overnight has been cuba, and it largely survived it.
Lets consider rationing in the UK during WW2, that worked, thats was centralled planned and was not a totalitarian state.
What mechianism would the "free market" employ? whom ever can pay the most gets the most, or all the food?  that strikes me as one sure way to fail.
"could never happen" tell me it wouldnt happen under a free market system either...above are two cases where central planning mostly worked.  I see no free market example at all.
regards
 

It has been well documented in the UK that privatisations have been a great sucess for one interesting group of people. To understand privatisations you have to understand who they are really for. They are obviously not for consumers, they are irrelevant, that is obvious. Slightly less obvious is the fact that they are not for investors either. Who cares about investors anyway. Mum's and Dads are marks, punters either through funds or direct they are at the bottom of the heap when the money gets doled out.
The people who gain from Privatisations are of course the managers, the accounting firms- Big 4 only of course, the lawyers, the Bankers, Shareboking firms especially.
You get the idea. This group through no central planning , direction or collusion knows exactly what is their own interest and the amounts of money they can make.  MRP had nearly all of them in the tent in one way or another. They are unstoppable there are big pots of money to be made and nothing to stop them taking it except Consumers and investors, voters, citizens and they have no chance. Let the feeding frenzy continue.

I dont understand the Hoohaa .

  • MRP has been run as a  business or "commercialised" with a profit motive for years
  • The Government still owns 51%, in other words  it controls the asset
  • It has not been given away to anyone, the govt has simply unlocked some value  , and it cannot leave New Zealand , its assets are fixed assets for the most part.
  • Labour and the Greens have successfully created an unnecesary emotionally and ideologically driven campaign against it 
  • Thank GodLabour / Greens dont run the show

MRP has been run as a  business or "commercialised" with a profit motive for years
 
Yeah Right!
 
These ambitions in the United States, Chile and Germany were once so important they influenced 70 per cent of chief executive Doug Heffernan's long-term incentive pay, although his current scheme, which began last July, doesn't mention them.
 
There is also a sense of changing direction in the announcement, which revealed the termination of a 10-year contract halfway through its term at a cost of US$25 million ($29 million).
 
These things happen, you might say. Sometimes you have to suck it up and move on.
 
However, a less forgiving view was offered to Chalkie by one professional investor, who described the announcement as "a frigging disgrace".
 
"You're the only investor in a fund, and to get control of your own money you've got to write out a cheque for US$25m. For these guys on the other side it's bloody Christmas.
 
"Things like this really highlight to me why you need a lot more visibility on the activities of these [state-owned] businesses."
 
There were other rude words too, but you get the drift.
 

Bradford doesn't get it now and he didn't get it then.  And introducing the red herring of nationalisation.  He should be embarrassed. 

[ deleted as abuse. Ed]

A market in electricity is essential.  Bradford failed miserably to do so.