This is a re-post of an article originally published on pundit.co.nz. It is here with permission.
Four centuries ago, theologians wondered how public virtue could be generated from private vice – they meant selfishness or, more euphemistically, self-interest. In his Wealth of Nations, Adam Smith gave an answer which posited a mechanism which reconciles the vice and virtue.
The mechanism was competition. As Smith famously observed, ‘it is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.’ Because the suppliers are each privately competing against others, the public benefits. Economics has gone on to identify when the competition mechanism works beneficially. Its answer is ‘sometimes’ – even often – but not always.
One issue is how many competitors are required in a market? If there is one – a monopoly – the answer is that it is unlikely that private vice seeking profits will result in the public benefit. At the other end of the spectrum, under pure competition, where there is a myriad of small suppliers, the answer is more favourable to the public interest. However if there are economies of scale in production or distribution or there is a high rate of innovation, the pure market may be a low productivity one, so that there are gains from having fewer players.
How few? A common view was that there had to be at least five significant players. Fewer, and the players would ‘game’ one another with an overall monopoly-like outcome in which consumers suffered. That suggests public regulation to ensure private vice delivers sufficient public virtue. Even when there were five or more suppliers, there might a need for public interventions in order to ensure ‘workable competition’.
Workable competition is a term which hardly appears in New Zealand’s public discussions, the notion having been trampled on by the neoliberal framework which abhors public intervention. It is easier to take this hands-off stance in the US, whose economy is fifty and more times larger than New Zealand’s. Even so the US seems to be going through major changes in its competitions policy thinking.
The reality is that for many New Zealand markets there are not enough players to let competition rip; looking to the US is hardly a good place to start thinking about the problem.
As it happens, New Zealand has five significant electricity gentailers (generator-retailers). Does that mean the electricity market can be left alone? But the rule of five is only a rough indicator and there is a particularity in our electricity which means it does not easily apply here. Implicit in the standard model is the assumption that all the players have access to the same production technologies.
That is not true for the gentailers. In particular, the supply of one – Genesis – is centred on a coal-fired station at Huntly. All the others are more dependent upon hydro-power. Huntly has a special role in our system. Because its thermal units have to be run much of the time – even when there is not a drought – it broadly sets the price of electricity. The economics is complicated but that the gentailers admit they game one another tells us that it is not the competitive market that Adam Smith had in mind.
What should we do? Could we increase the number of gentailers? But that would not reduce the special role of the Huntly station – the rule of five suggests we need five independent thermals. More promising is that we need to restructure the industry to, in effect, be a monopoly regulated in the public interest. This not to rule out private suppliers, but competing generators would sell to a monopoly public agency who would then onsell to competing independent retailers.
This proposal is not very different from the old system of a state-owned Electricorp (except that generators were largely state-owned). The restructuring in the 1990s was heavily influenced by market theories based on financial markets (and certainly financiers are having a great time in the current electricity system). Producing electricity is very different from producing financial paper.
The case for restructuring the industry is strengthened by major future changes. Here are some.
The Huntly coal-fired stations will have to close in order to meet our emission commitments.
Replacement supply will mainly come from solar and wind farms. Currently market arrangements favour corporate farms but I shall not be surprised if, despite industry protests, we make it easier for others – farmers, houses and commercial buildings – to contribute to the grid.
A general problem with the dependence on hydro, solar and wind power is that their generation does not always match demand. To some extent, we can ‘store’ electricity in the hydro-lakes but that is increasingly insufficient to deal with the mismatch, an effect which will be compounded when Huntly closes. Fortunately the cost of battery storage is coming down. The state of Victoria is already installing ‘Big Battery’, a 300 MW grid-scale battery storage project in Geelong. (Each Huntly turbine is 250 MW.) As costs come down, small solar and wind suppliers will have their own on-site batteries.
There is the Lake Onslow proposal which would increase hydro-storage capacity. Its economics is likely to be undercut by the batteries. When the government asked for comments, each of the big gentailers argued against the proposal on the basis – to put it crudely – that it would upset their profitability; as you would expect from private-vice considerations.
The closure of the Tiwai aluminium smelter will release Manapouri’s electricity capacity equivalent to about a sixth of total generation. What to do with this surplus? One proposal is to use the energy to produce hydrogen for export, a logic which would be favoured by the private vice of the gentailers because it would not threaten their current pricing (and profitability) arrangements. Another option would be to send the electricity north. (I am told the capital cost would be only $600m; the Lake Onslow proposal is about $4b plus reticulation.) That would mean that we could close Huntly faster and cheaper but it would hurt the other gentailers’ profits.
There is a danger that the current review of the electricity industry arising from the recent blackout will (once more) fumble the issue by looking at how to patch the current system rather than considering the major restructure the future requires. It takes a lot of courage and competence to face such a future rather than hide from it. The Clark-Cullen Government showed it when it restructured Telecom, splitting it into competing Spark and regulated-monopoly Chorus. That facilitated the broadband rollout which, among other things, contributed to the success of the covid lockdown. Can the Ardern-Robertson Government step as confidently up to the plate?
Footnote. The story of private vice and public virtue is brilliantly told in Benjamin Friedman’s Religion and the Rise of Capitalism. Later chapters discuss the rise of the gospel of wealth versus the social gospel, which is the economic theology underpinning America’s current political divide.
Brian Easton, an independent scholar, is an economist, social statistician, public policy analyst and historian. He was the Listener economic columnist from 1978 to 2014. This is a re-post of an article originally published on pundit.co.nz. It is here with permission.