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Gareth Morgan explains why you should be worried about the Labour/Greens electricity proposal

Posted in Opinion

By Gareth Morgan*

The Labour Greens proposal (NZ Power) has sparked a long overdue debate about electricity prices.

Despite what National claims the NZ Power model is perfectly workable, and indeed similar models are in place overseas.

The real question is whether the idea is a sledgehammer to crack a walnut? We think so.

The NZ Power proposal is classic politicking; a solution in search of a problem.

Labour and the Greens have thrown up a grab bag of different reasons for it including fuel poverty, power companies using free water, price gouging and asset sales.

Let’s take a look to see how the arguments stack up.

Fuel vs Poverty

Fuel poverty certainly exists, along with food poverty, health poverty and housing poverty. But really isn’t it all just poverty?

And like all those problems the solutions to poverty are better found in our tax and welfare system than in tinkering with our electricity market.

There is little reason to think that the benefits from the Labour/ Greens proposal would go to the people that actually need it.

Private Hydro Companies Use Public Water

It is true that hydro power generators get paid a lot more for the power they generate than it costs them to make the power. This is because hydro is so cheap to run compared to all other forms of generation. In the old days Electricorp and its predecessors only charged for power based on the average cost of generating the electricity. This meant that we all got the benefits of cheap hydro power.

Nowadays we use marginal cost pricing, which means we pay for all electricity based on the cost of the most expensive source of power used. While this has meant prices have risen, the system actually makes sense because it gives the right incentives both for power generators to build new power stations if there is too much demand, and for consumers to conserve power. The result is that we as a society, use the optimal amount of power.

Labour and the Greens now think it is unfair that the private power companies can use dams our nation built and water that (supposedly) nobody owns to generate power at a huge profit.

Let’s be clear though – shareholders bought those companies at the going rate and so the Government has already reaped the benefit from these profits – the sale price the Government got was far higher than it cost to build the dams in the first place. It was based on charging the marginal cost of electricity in future.

If it is now deemed unfair that hydro generators can use water for free, then charging generators for water use would be a better remedy than tinkering with the electricity market.

In fact this is exactly what we have previously suggested also needs to happen to other commercial water users, such as farmers.

Such a charge would not affect power prices (because hydro is so much cheaper than the alternative generation which underpins the market price these days) and the revenue could be used to improve our rivers, shared amongst taxpayers, or as a rebate to electricity users (if power prices are seen as the problem).

Price Gouging

There have also been various claims of price gouging in the electricity sector. With five large power generators, manipulation is certainly possible. However, as yet there is no evidence of price gouging – wholesale prices have recently been pretty stable.

If anything, the competition problem probably lies in the electricity retail side. This could be solved by a lighter touch approach – ensuring that there is a decent hedging market in place. A hedge market would allow anyone to get long term certainty about electricity prices – whether buying or selling it. This would mean that independent generators (including for example households or communities with wind turbines) and retailers could enter the market without fear of being stomped on by the big guys that have both generation and retail arms and might be able to manipulate the spot market.

Risks with NZ Power - Investments

At the moment the electricity market sends lots of signals to the generators and users of electricity to help them make their decisions. The NZ Power model would mean government takes over the responsibility (and risk) for getting these decisions right. Does a Labour/ Green government really want to bear that extra burden?

It can be done, but it isn’t easy.

Firstly they need to overcome the legal challenges that are likely to come from hydro generators as a result of writing down the value of their assets.

Then they need to dodge the inevitable industry calls for Government to bear the risk of supply disruption.

Then they need to set the prices, a role that the market does now.

Set them too low, and investment will dry up. Set them too high, and we will get an excess of power supply.

If this happens (or demand drops as it will when Tiwai closes) it becomes difficult to drop prices, as NZ Power will have guaranteed a return on assets, so prices end up higher than they need to be.

In most countries where this approach has been tried, conservative government officials tend to opt for too much power, just in case.

Risks with NZ Power – Environment

The Labour Greens proposal is also strange given their stance on the environment and Emissions Trading Scheme.

All power generation has an environmental impact (even wind), and if we drop power prices then people will probably use more. That means more power stations.

Contrast this with their plans for the Emissions Trading Scheme, which would increase electricity prices.

This would provide an incentive for electricity consumers to reduce their power use, so we have reduced need for new power plants (especially coal and gas ones).

It seems weird to have price controls aimed at reducing power prices and an ETS aimed to increase them.

What Could Be Done Instead?

However there is still hope.

The ‘lighter touch’ solution of a futures or hedging market set out above could be picked up by National as a middle ground. Or the Labour/ Greens proposal could be subtley reined in to similar effect.

Either way, lets hope that electricity doesn’t become another political football which flip flops with every new Government, like the top tax rate, ACC or superannuation.

In summary, here is our 3 point plan for the electricity sector:

  1. Charge hydro generators for the water they use (this wouldn’t affect the price)
  2. Regulate the hedge market, to improve competition (this should drop the price, especially on the retail site)
  3. Hurry up and close Tiwai, which should drop electricity prices by 10%, plus save the Government any future bribes (such as the recent $30million payout to Rio Tinto)

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Gareth Morgan is a businessman, economist, investment manager, motor cycle adventurer, public commentator and philanthropist. This opinion piece was first published on his blog garethsworld.com and is reprinted here with permission.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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10 Comments

Oh Gareth.  What

Oh Gareth.  What twaddle.
Gareth would need to explain some things.  Like what is the relevance of a 'return' on a hydro dam bought and paid for decades ago.  We should be paying running cost only (minimal)  repair (minimal over time) and for eventual replacement (not much spread over the extended life of these things.)
Why would we pay some notional % as a 'return'.   Which in relation to the items above is works out to be huge.

KH the twaddle is all

KH the twaddle is all yours.
 
The concept that the dams are "paid for" and therefore we should pay less for thir power is rubbish and applies to no other industry.
Rent a renovated old house vs a new house  - get any difference in rent? - no.
Buy a car produced from a factory built in the 70s vs a facotry built yesterday - get any difference in the price of the car? - no
Buy a coke (IP and brand developed 100 years ago) - should coke now be cheap? - No
Buy food from a famr thats been farming for 100 years, surely the farm is paid for now? The food should be cheap!!! -  No
We pay the market price. If you think there is so much money to be made in power then buy or build your own power company

All activity above

All activity above subsistence requires a surplus. So the construction of a damn occurred from resources available at the time, hence KH is quite correct in that it is already paid for.

Scarfie - while it is correct

Scarfie - while it is correct that hydro has very little marginal running cost relative to traditional thermal (gas) power, the upfront capital investment is tremendously larger.  Therefore even though it has a marginal cost advantage prices will still need to be high (ie, the dreaded super profit) to earn a similar return on investment.  It's a bizarre concept - a power source that has free raw in ingredient (water) compared to a thermal power plant that has to pay for its raw ingredient (gas).  The difference is in the upfront capital expenditure and the net result can still be an equivalent return on investment.

Except its already been paid

Except its already been paid for by previous tax payers, hence really its producing for 3 or 4 cents a kwh, the capital costs we met via taxes.
Now the marginal cost is where it bites, new plant does indeed need capital and has to be paid for, but multiplying the value of the old assets to derive a "fair return" is ludricious.
On top of that treating a Govn sanctioned monopoly as the same as a business when we have to and require resiliance for our economy and society is silly.
No one for instance requires the police to make a profit, they are essential, so to are utilities.
Somewhere in between is something sensible and fair.
regards

TraderX.  You believe in the

TraderX.  You believe in the idea of a 'return' on the what was spent building these dams like it was a feature of nature, fixed and immutable.   Can you actually explain why that is.
Buy yourself a new car.  Who do you pay the required return to every time you use it. 

Gareth, you forgot about PV.

Gareth, you forgot about PV. Higher grid prices makes alternatives viable sooner. Well done for walking on eggs without breaking them though. What have you done with the old Gareth Morgan, firebrand and provocateur?

The only solution is real

The only solution is real competition

By suggesting a hedging

By suggesting a hedging market, Gareth alludes to the main problem with the current system, without fully explaining it in my view and as I understand how the "market" works.
The current generators/ retailers maximise profits and importantly, minimise risks, by having their retail market share be more or less equivalent to their generating share.
For arguments sake a generator's fully loaded average variable cost per kwh might be say 10c, spiking a little up or down if they have to use more fossil fuels vs renewables. The retail price might be 20c. If their market shares for both generating and retail are very similar, they actually don't care about the wholesale price, as that will be paying from one pocket into the other. If however they are short of generating relative to retail, they are exposed to the wholesale price rocketing up to say $1 a kwh in cold, water short times. They could lose all their gross margin for a quarter or even a year very quickly.
Conversely if they have surplus generating capacity relative to retail, they are exposed to the wholesale price dropping to 5c in a warm wet winter, so taking them below cost.
Either scenario is also vulnerable to aggressive predatory pricing, (which the hydro companies in particular are well placed to do), so a retail only or generating only entrant would be especially vulnerable if they grabbed more than a token market share.
So the current market, even with a lot of switching, is really not all that competitive, as each main company will want, and only want, their market share.  For each switcher they lose, they'll make sure they get one back.
A hedging market would solve this up to a point. I'm not sure it couldn't be gamed by the big guys, nor that a new entrant in one end of the supply or the other wouldn't still be vulnerable to a moderate real move undercutting against their hedged price, and leaving them still well out on a limb.
The idea is nevertheless worth some exploring. Failing that I struggle to see a successful market without a degree of centralised direction or control. It didn't really matter when the winners were all citizens and taxpayers; but now it does matter.
 
 

The summary made sense. The

The summary made sense. The rest was just static noise.
No3 was funny and not well liked by Nat fanboyz.