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Geoff Bertram proposes NZ regulate electricity pricing so that only indexed historic costs can be used to set prices as is done in England

Geoff Bertram proposes NZ regulate electricity pricing so that only indexed historic costs can be used to set prices as is done in England

By Geoff Bertram*

A year ago, appearing before the Select Committee considering the Mixed Ownership Bill, I warned that the regulatory risk overhanging the electricity industry had become severe, and that it would be unwise to proceed with any partial share floats without first ensuring that investors could be confident of a stable policy and regulatory environment.

Specifically, I pointed out that “New Zealand’s regulatory regime to date has been spectacularly lax by the normal standards of regulation in other countries, and any investor taking up shares in the pending floats of electricity SOEs will have to bear in mind the likelihood of a future policy shift that will more effectively remedy the obvious failings of the industry to date.”

I drew the committee’s attention to more than $10 billion of asset revaluations that the generator/retailers had credited to their books.

That sum, which had risen to $12 billion by 2012, represents the present value of the amount by which those companies’ profits are above what would have been needed to give them a fair return on all the money they have paid out, both to acquire their generation assets back in the late 1990s, and to install new assets since then.

I pointed out that if one of the standard models of regulation used overseas had been applied here at the time ECNZ was broken up in the 1990s, most of those asset revaluations would have been prevented, because the industry’s ability to price-gouge its captive customers and capitalise the resulting profits as “fair value” would have been blocked. 

The central reason for regulating the New Zealand industry would have been to hold prices and asset values down to the lowest levels consistent with security of supply.

One example of such regulation was introduced by Margaret Thatcher’s government when it privatised electricity and other utilities in the mid-1980s.

Britain’s “RPI-X” regulation was designed to hold electricity price rises below the inflation rate, thereby forcing companies to pass through efficiency gains to consumers in the form of lower prices.

Much of the USA, meantime, continued with its long-established practice of rate-of-return regulation, which allows investors a fair return on all money they actually spend on building plant and equipment, but blocks them from helping themselves to the sort of “fair-value” revaluations that New Zealand generators have used to justify their price-hikes over the past decade.

So how big is the regulatory risk facing the electricity generators?

Suppose a New Zealand Government regulates the big generator-retailers. The first decision would be to decide how much of the companies’ declared book values would be allowed to stand.

A US regulator would aim for a write-down to historic cost; a British one would settle for indexed historic cost (that is, they would allow regulated asset values to have risen with the consumer price index since the assets were “vested” in the new companies).

Either approach would sharply reduce the value of shareholders’ equity in the companies and bring down the amount of revenue they would be allowed to collect from consumers.

On the basis of the 2012 gentailer balance sheets, write-downs could total up to $12 billion, and revenue reductions could be well over $1 billion per year.

As a specific example of a New Zealand electricity company’s exposure, it may be worth looking at the numbers for Mighty River Power.

Mighty River’s fixed assets had a so-called “fair value” of $5.1 billion at June last year, but the historic cost of those assets was only $2.2 billion. A regulator using historic cost could potentially require a write-down of nearly $3 billion, and a corresponding cut in revenues (achieved by price reductions) of between $300 and $400 million.

The shareholders’ equity was just over $3 billion at June 2012; most of this would evaporate as regulation came into effect.

Alternatively, a regulator could allow the company to set its prices to secure a fair return on indexed historic cost, in which case I estimate that the allowable asset base would be $3.1 billion, requiring a write-down of only $1.9 billion (about two-thirds of equity).  Allowed revenue would be reduced by roughly $250 million a year.

In my submission to the select committee last year I proposed a regulatory regime based around historic cost and progressive pricing, and I commented that such a regulatory change “would be financially devastating for the balance sheets of the SOEs, in precisely the same way as their conduct has been devastating for the household budgets of millions of people”.

But the world would not end; the electricity market could continue to operate, and the existing companies would be able to trade forward once recapitalised. All that would have happened would be that their massive expropriation of wealth – a sum equivalent to around 5% of New Zealand’s GDP - from ordinary consumers would have been reversed.

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Geoff Bertram is a Senior Associate at the Institute for Governance and Policy Studies at Victoria University.

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53 Comments

Now the bleating from National should evaporate. They were told and the same from the financial brokers who could see a loss of expected income from the float.
However on the positive side, including the Labour/green proposal the extra $300m+ would be spent elsewhere and tax revenues on that would be substantial so reducing the hit on SOE income.

This guy makes sense to me.....and he said this in front of a select commitee.
I drew the committee’s attention to more than $10 billion of asset revaluations that the generator/retailers had credited to their books.
Wow... even a kindergarten kid could have forseen the implications of this...... that at some point this blatent game ..that is a rort... would be found out and dealt with.
AND... here we are today...  It is kinda perverse that it is in the face of a partial privatization..that this is being..."played out"..
Shakespeare could not have written a better scene/play.

So - the value at which a person should sell something should be determined only by what it cost them.
 
Suppose you own a painting by Van Gogh.  You inherited it from an ancestor who paid three groats for it in Europe 120 years ago.  It's worth millions on the international art market.
 
Why then are you not willing to sell it to me for $100?  That's $100 profit to you, isn't it? 

MdM
Fair argument, but who "owned" ECNZ? I'd propose that the citizens of NZ "owned" ECNZ and their elected governers (The NZ Govt) have hoodwinked them, magicing 10 Billion from thin air so they can pursue their own agenda whilst touting that the aforesaid citizenry will be better served by the "free market" whilst paying more for their electricity (and this was their electricity in more than one sense of the word)

Six differences MdM .. captive .. essential .. everyone has to have one .. reproduction .. fake .. not original .. value of a Rembrandt or a Van Gogh is its scarcity one-off nature

No... I don't he is saying that at all..
he is talking about an industry that is both a Monopoly and also an essential service... ( the oxygen of our economy ).
This industry is regulated...   The loophole in the regulation is that they are allowed to make a "reasonable return" on assets..
SO..what do they do... they revalue all assets up..and up...and up..
I don't think Comparing this to Van Gogh  is a good way to understand what this guy is saying.

Its known as a straw man argument I think...take something to an extreme position never intended by the proposer in order to show its "unwise" and wont work.
I agree on the re-evaluations rort...really its gone way to far and a con...the only Q is, is Labour that innocent of this? suspect not.
Interesting that actions always speak louder than words, the Nats are busily losing the next election...never mind JK will enjoy his retirement in hawaii im sure, BE might find the South a bit cold though.
regards
 

Doesn't work like that with Electricity MdM.  Even if it does for other things. 
For example I own a multi tenanted property built in the 70s.  Had several owners before me, most of whom I guess had a capital gain.  All of those sale prices will have been steps above initial construction cost.  I receive rentals several times that from when I started and could sell it right now for multiples of what I bought it for.  At the right time (hopefully) I will do that and be very happy. Or I might keep it and be very happy.
But also I am not immune to a market with that one.  It's eminently possible that conditions will change, tenants at renewal, might just say 'no thanks' or as happens when conditions really change, simply decamp.  I face risk from changed conditions and not least competition from some other landlord.
My problem at that time, and nobody elses.
I suppose I could examine the lightshades and decide to revalue the thing up somewhat, --  that 10 billion does sound attractive.  And write a letter to tenants telling them of their expanded new rental rates.
That will work - Yeah right.
But similar revaluation has worked in the electricity industry.  Because by it's physical nature it is a natural monopoly.  And also by inept government inaction it is protected.
I'm not enamoured of the labour / green proposal.  We don't need a command economy.  But we do need an effective referee in this situation.  We need a real market.
Overall, it's a great article.    

I don't know enough about you personally to ascribe motivation to you, so I'll posit the example of an owner of a block of flats. His options are to sell it, or to rent out the flats.  Assuming that his objective is to maximise his own profit, he should do whichever of these he thinks will bring him the most money.  At the moment he thinks the value of the income stream from the rentals is more than he would get from selling the building.
 
Now the value of the block of flats goes up.   The landlord is now earning less from the rental than he would if he sold the building; and so the calculation changes.   Again assuming that the objective is to maximise profits, he should either sell the building, or put up the rents.  This is true whether or not the increased value of the building is due to anything the landlord has done.
 
The point here is to argue that it is not a distortion or a rort for the provider of a good or service to take into account the opportunity cost (what else could he have done with the resources that he used to provide it) in deciding whether to sell that good or service at a particular price.  On the contrary, it is absolutely consistent with the objective of maximising value.
 
What stops the landlord from unilaterally declaring that the value of the building has gone up, although in fact it hasn't really, and imposing price increases on his tenants?  The fact that his tenants can move to another, more reasonably-priced building.  By demanding too much, he risks losing the income stream, and he will not be able to compensate for that loss  by selling the building (since it is not in fact worth what he says).  His competitors will benefit by gaining his former tenants.
 
Now if the tenants are dopey and apathetic, this discipline will not be present and he may well be able to extract more from them than is justified by the real values involved.  But whose fault, and whose problem, is that?
 
 
 
 
 
 

Ms de meanour...    
Sounds like u percieve the whole elecricity market as being in the same realm as rental accomodation....  in terms of market forces determining prices..??? ( both for asset values and prices charged).
I think there is a vast difference....  and that is why the electricity industry is subject to regulation.
Maybe once there is a  true alternate, price competitive, choice, ..such as solar power.... then, I would suggest, NOBODY  would care how much Power companies revalue their assets.....they could use any method they liked.
Until that happens ...I view the whole indusrty as being closer to a monopoly ...rather than a open competitive marketplace.
Geoff bertrams views about revaluations only really make sense if u  agree that the Industry is closer to being a Monopoly rather than a marketplace economy....   and that revaluations are their way of getting around the regulations.
just my view...
 
 

MdM @12.49.  Your paragraphs 1-4 are not wrong,  But miss the arguement.
The clients of the electricity are locked in.  It is different.  It is theoretically possible to bring in a second line beside the first one an connect to a generator in any part of the country, provided you build your own line all the way there.
But for most of us, that is a practical absurdity, it's not an available option.
Paragraph 5.  Some of the tenants/customers of the electricity non-market are indeed dopey and apathetic.  But most are not.  However physical infrastructure and political ineptitude lock them into overpriced supplies.
And there is an attempt to do something about it.  The article above is a very reasonable one and suggests part of the approach. 
   

Yes, the transmission and distribution of electricity is a natural monopoly activity.  It should be regulated as such.   
 
The generation of electricity is not a natural monopoly.  Neither is its retail.  Both can be carried out within a competitive market.  Just because there's only one road from A to B, doesn't mean that only one bus company can offer bus journeys along it.  Neither does  the same company as runs the buses have to be the one that sells the bus tickets.

In the electricity market, the generators and retailers magically all have similar market shares for generating and retail, as they can game the margins externally versus internally. So a new generator will only be able to sell its capacity at peak times, and be idle the rest of the time, as it would have no customers. So no business case to establish would be feasible.
A new retailer would have to always buy on the wholesale market, which would be artificially expensive, (or even may have no supply at absolute peak times) such that no sensible retailer would try and do this in the current arrangements.
The Labour/ Greens proposal gets around this dilemma; allowing scope for new generators without an existing customer base; and new retailers without assured supply. It should therefore be more competitive, not less.
 

No, lets take it to un-reasonable extremes to try and "prove" a point of someone who holds extremist views that make no sense in a society for 99.999% of the people.
There is a difference between a strategic asset the cost and use of which impacts NZers and the economy and often therefore has a govn granted monopoly and a painting that effects no one but the 2 parties.
The former should be regulated heavily to ensure other areas of the economy prosper.  The latter is no one elses and especially Govn business.
regards
 
 
 
 

I don't know that is a good comparison as while there is a open active global market for Van Goghs, and a limited local market for power, there is no liquid market for power stations. As the power stations only service this country, it is more of a situation of a small cozy collection of market players able to charge captive market rentals on their assets (and power is very much like renting the use of a power station). In general throughout history monopolies and near monopolies have always attracted attention because they have traditionally abused their captive markets
In the case of the Labour/Green plan of forming a single purchaser, the question then becomes what is the fair price to offer to buy the power at. I would suggest, since the market power is shifted to the consumer, this is likely to be less than the amount that the generator asserts on the basis of agreement with the other members of the generator cartel. Conceivably, it might be appropriate to base a price on the way other jurisdictions have handled such matters (hence the above article).
To use your own analogy, you may have a Van Gogh bought for three groats by a distant ancestor, but if you can't ship it overseas for sale and the only buyer is the bloke down the road, you won't be able to sell it for whatever you want as you will have to meet the local market (lets pretend the Van Gogh is too large to ship overseas and embedded into the ground). Now if the bloke down the road wants to keep buying Van Goghs (this is why rental metaphors work better) and encourage you to produce more he will offer a price that makes the continuing production of Van Goghs worth while.

But consumers do have power.  They have the option to switch to a cheaper provider.   They are not using that option, despite continuing encouragement.   If they did, providers would have to make more effort to keep their prices competitive, otherwise they'd lose market share.
 
Let's accept for the sake of discussion though, that the Government accepts it has a duty to act on behalf of those who won't act on their own behalf.  As you say, the Government then has to decide what is a "fair" price.  Yes, it would be lower than that dictated by a monopolist provider, or that agreed between members of a cartel. 
 
But it still has to be high enough to ensure that it is worthwhile for the producer to keep producing.  And that does not depend on what it costs him to produce.  It depends on whether it is worth more to produce, or to sell off the producing asset.  Under the central-purchaser approach, Government now has to second-guess that.  Do we think that Wellington bureaucrats and politicians are well placed to do so?

MdM
You clearly "don't get it", Consumers can only switch retailers, the wholesale market is stiched up, As one commentator said you can jump from one upward escalator to another. The only way thay can bypass the wholesale market is to produce their own power which they can only produce at the marginal cost of new production, the SOEs are laughing

"Do we think that Wellington bureaucrats and politicians are well placed to do so?"
That is kind of what the next election will test (though I think everyone will be interested in the results of the opinion polls taken after the Labour/ Green announcement). For the pro-privatisation National's policies are great people the choice is pretty clearcut, for the anti-privatisation pro Labour/ Greens people the choice is pretty clearcut. For those people who feel the current market setup isn't working but don't like the Labour/ Greens, they are either going to have to abstain or choose one of the two options. For this third group, issues like "This model of market does work overseas, so is there any reason to think it cannot work in NZ?" are valid questions worth considering.
"But consumers do have power."
Citizen's, who as consumers might feel they do not have the knowledge or time to actively take part in the market, can also vote for policies to be collectively represented in the market. "It depends on whether it is worth more to produce, or to sell off the producing asset" True, but they would be selling the asset to someone to produce power with, power stations not being easily repurposed or shipped to new locations. That said, we know that this model can work overseas delivering functional power markets that people want to invest in (including our own SOE power companies), which suggests a fair return is possible under such models.
Studies of apes suggest that fairness is fair more important to apes (including humans) than the opportunity to exercise individual greed. The Labour/ Greens policy would have no traction if people felt that the market was delivering in a fair way.
"Let's accept for the sake of discussion though, that the Government accepts it has a duty to act"
I don't know I'd go quite that far, could we compromise on political parties have the right to bring different policies into the marketplace of ideas, and we as citizens can consider the evidence for how well they work?

MdM.  The point again.  Consumers don't have choice of any significance.  We have an ineffective market.

Wouldn't dispute that there is scope to make the market work better.  But that is not to say that anything would be better than the present approach.   My case is that the particular approach proposed by Labour is not likely to be effective. 
 
And that consumer moans about high prices would be more convincing if they'd made any effort to help themselves.  I might moan that I'm overweight and unfit because there's no fancy gym in my neighbourhood and I can't afford a personal trainer; but you might not be very sympathetic when you learn that I live near a beach where it's perfectly safe to swim, or close to a public park where there is a well maintained running track for public use, and that I've made no effort to utilise either.

MdM - fully understand where you are coming from.
The real and free market vs illusion and controlled markets.
 
The recent posturing by Labour and Greens if ever implemented will see cost rises in other areas.  Looks like a number of people want to pay for 3 goats worth of power annually and won't mind incurring Van Gogh prices elsewhere in their annual budgets.
 
 

Same applies to revaluation of local body assets .. thus local body rates ..

MdM .. Issue can be summed up in your art world " market " view.
The problem is that the electricity market is grossly distorted and subject to gaming. No one can build another hydro in the North Island and the generators know this. The generators are location sensitive due to transmission constraints. Hydro generators have unique capabilities such as load response times and virtually infinite life cycles with near zero maintenance.
Gas is not available for long term investment of scale and no one is prepared to pay capacity charges - required in a mature market.
The price of entry runs to hundreds of millions of $'s - so no new entrants of scale.
I can't accept the generators meet conventional market definitions - and once that is assumed you start to look at the next best alternative approach which the rest of the world has found to be regulation.  We are not unique in having these issues.
It makes good sense  to simply follow best practise - after all we don't even have the GDP of Melbourne City so ae not going to be " world leading " in anything.

Would not a capital gains tax sort this problem out real quickly? By increasing the fair value of their assets they are creating an increase in their company's capital value. So why not tax it.
I note that Auckland City (in the new plan) is proposing a property tax, to tax the gains between the purchase price of land and the gain when the zoning permits subdivision. Just another weath tax like Capital Gains but at the local level.

Good article, and hits the exact process.
 
Useful to note that precisely the same mechanism (revalue assets, make an agreed return on that value) is at work in the following cases:
 
- Council-controlled companies
- Airports
- Ports
 
Common taters may well be able to expand the list :  and it warrants a follow-up piece, methinks, Interest'ed editors.
 
After all, to the extent such entities are publicly owned, their annual accounts will be online, and the Revaluation Reserve (on the Equity side of the Statement of Financial Position) is where the bodies are buried.

Interesting to note that several of the SOE power companies are using their "unregulated" profits to invest in "regulated" overseas markets ..

Chasing profits I suppose....Like WTF is a NZSOE doing investing overseas?
btw url(s)?
regards
 

Steven - you gotta listen to the chatter a bit more
here's one of them - came across something about it 2 years ago while researching solar offerings and costs in new zealand - bit surprised
http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10644775
 
Then last week there was a comment (chatter) about one of the NZSOE's taking a hit on their south american electricity investments (was it chile?) cant remember

hehehe, I thought I'd read something, just wanted it for reference, thanks btw.
Afraid im busy with other projects of interest to me so time is at premium, besides which this is mostly done I think, time to look at what to do in the future.
I really have to Q why Meridian is busy overseas...like crazy. It really has to be because they are driven by the need to keep profits / dividends high for their shareholder(s)..yet another regressive tax.
regards
 

If we can regulate the power price, can we start lobbying the govt for fair parking fees in Auckland and Wellington?

CM - why stop there? We could start lobbying for a reduction in all bureaucratic costs, public servants salaries,  taxes, WFF etc. These things are all too expensive and should be regulated immediately for the greater public good.
 

No, the original argument is there is proveable excessive profit and the Green's and Labour want the future costs to be far more neutral. Not that its too expensive to do something by your guess, a rather large difference.
regards
 

"the original argument is there is proveable excessive profit".
So lets look at a typical parking meter space in shortland Street, Auckland or Featherston St, Wellington which constantly being occupied for majority of the time; $4/hr, 10 hr/day, 250 working days = $10,000.  Plus 50 weekend days at $2/hr (50 weekends) = $2000 - Total $12000.. Now is that excessive for a space of 2x4m with bugger all maintenance costs????

Yes and no.
Its something I will never use, so its optional, and even then I could choose a cheaper spot and walk.
regards

Steven - Generating, distribution and using power is a business for everyone.
If people want the luxury of certainty of power supply and the benefits that certainty offers then as a user they have options. If they use power they can invest in shares in power/energy, they can invest in alternative types of power for their supply needs, they can invest in reducing overall consumption etc.
 
If Nanny state interferes people won't take the intitiative an invest in practical solutions. Labour and the Greens know this only to well and that is why they are posturing.
Every business has to do be in business to maximise profit. If your not maximising profits you are not able to invest in newer technologies and advances that are made.
Take the telephone system that we now all enjoy. Think back to the old days of manual exchanges and party lines etc. If Labour and Greens had decided to implement similar policy what sort of an antiquated phone system would we have now? Exchange operators still able to listen into phones calls along with the neighbours who shared the same party line etc.
 
NZ enjoys a very good and mainly undisrupted power supply in most areas. If Labour and Greens keep up this fiasco and did happen to get elected and implement this policy then in the long term expect power interruptions and a few other issues to arise out of this nonsense.
If people use power then investing in the power they use is sensible. No one has more interest in an individual than the individual yet how many people abnegate their responsibility to themselves and then whinge at the Government and then wonder why there are so many problems.
I can almost hear the glee and hand-rubbing of people who think they might be getting something cheaper without stuff all effort from themselves - this is greed in action and it will bite them on the proverbial in the end.
 
 
 
 

Sold my first house to the operator who listened in on the line.
 
Saved me an agent's commission.
 
Spent it on an Austin Maxi.
 
Ah, the good ol' days.

Classic!.......We had one particular old girl on our local exchange who would listen in constantly so we used to feed her up on lots of stories.....it was amazing how quick the BS  got round town.
 
Have to admit those operators were damn good in an emergency and they knew where everyone lived. The'd even phone the rellies and tell them what was happening.
 
 

Our one was called Pat.
 
Remember the thrill of getting your own line to the exchange - much better than the party line we thought ....
 

NanE, time and time again you have a Libertarian "free market"  view of the world that I see no evidence can be backed up, and in fact 30 years to show what a disater its been. Besides which we live in a society where we make choices. When we look here we can see that the Govn granted monopoly has been abused by both the Nats and the SOEs, this has disadvantaged poor NZers and many businesses. Yet again you bring out straw men, Telecom in 1998 usurped Saturn's plans to offer cable modems by doing adsl that was simply an abuse of power.
In terms of ppl getting something cheaper, yes thats right and proper. They are in fact at a dis-advantage having no leverage and hence Govn stepping in and using regulation to do so is fit and proper for a govn.
Dont like it? well you have the voting booth.
regards
 

Steven - you don't understand a "free market". If you think the last 30 years has been a free market model then you are very mistaken. As you state the Government has created a monopoly and that monopoly has been there a long time. That is not a free marker is it?
So don't give me the Libertarian free market doesn't work when it has not been implemented ever.
 
 
Telecom hardly operates under a free market when you look at all the regulations that they have to abide by.  Was Telecom protecting their position in the market or abusing their power? If I come along to your place and said I want to use your house as a thoroughfare would you agree? Or would you tell me to get lost? or would you take any number of other options available to you at the time? Would you try and protect your patch?
 
Is it the Governments role to get people something cheaper? Or is the people's role for them to get themselves a better deal?
Where would you suggest the interferring starts and finishes? Some people might think you get paid to much to do what you do and request the Government to regulate your industries wages/salaries with a small margin - I take it that you will be quite happy for that to happen. Interferring in the markets creates price distortions as it can lower prices and elevate prices. Then there is the cause and effect momentum from the interference that creates other price distortions in other markets along the way.
 
If power is cheaper people will use more because simply because they can afford to.
 
 
 
 
 
 
 

Well, I hope the Government run local Food Store keeps you fit and healthy.  Because " I see no evidence can be backed up, and in fact 30 years to show what a disater [sic] its [sic] been" is shurely a Sweeping Generalisation if ever I read one. It cannot really be said to apply to most areas of life.
 
Care to qualify that statement, in the Interest of all?

This is probably the best suggestion I've read so far on the power question.  The fully free market approach that both governments have subscribed to so far is not working and Labour/Greens nationalization proposals would be rather costly for the tax-payer and would result in horrible service.  This option combines the efficiencies of the free market and the price constraints from light touch regulation, without having to create a NZ Power entity full of costly bureaucrats.
 
Should have guessed that a expert would come up with the most logical solution and be ignored. 

Sounds like a well thought out article, unlike some of the rubbish spewed by politicians this week. Imagine a nation that is governed by a party that resorts to name calling when they disagree with you...
Been pretty disappointed with National in the last week.

doan-choo-wurry none little bunnies .. doan-be frightened .. all the little bunnies will go to bed tonight having uncle remus bedtime stories read to them and Brer Rabbit will slumber off dreaming about Li'l Miz Molly Cottontail .. tomorrow will be another day .. another hot-topic .. all will be forgotten

In the current market asset values have absolutely nothing to do with the wholesale or retail price of electricity. These prices are both set at what the market will bear, subject to minimal regulation which also does not take asset prices into account.
 
There is no need for a generator or a retailer to use asset prices to justify their price hikes, because these price hikes are not regulated. So what is Geoff Bertram on about?

Gaunt @  2.48.  But the return / asset ratios have been used to say that prices are not excessive.  Because the returns are not so great.  Apparently.
Of course thats fradulent.  Because the asset values have been artifically inflated.

[citation needed]. Who is actually saying that, besides Geoff Bertram?

You reach the nub of it KH. 
 
How do we know in this case that the asset values have been "artificially" inflated?   How would we determine what would instead be a "fair" valuation?
 
The case I was trying to make is that an asset should not be valued simply at the price that its present owner paid for it, plus inflation and/or any improvements he has made.  That seems to be what Geoff Bertram is arguing.  He talks for example about the US system, which "allows investors a fair return on all money they actually spend on building plant and equipment". 
 
But - and this is the only point I was trying to make in my original intervention, though I've got sidetracked since -  what an asset is worth is nothing to do with what you paid for it.
 
I've given an extreme example as illustration, but there are many others.  Shares, for example; houses, gold, race horses, customised cars. 
 
I will not sell it to you if somebody else is prepared to give me a higher price, even if it cost me nothing in the first place. 
 
Nor should I expect you to pay me a high price for it if somebody else is prepared to sell it to you for a lower price, even if I paid a fortune for it in the first place, or have spent masses of money on decorating or training it. 
 
 
 
 

In fact, it's probably, mischieviously, possible to posit an argument re values that runs like this:

  • all generation has environmental side-effects.  Think, dams flooding valleys, geothermal draining Gaia's - er - therms, windmills blotting out ppl's views, causing infrasound and killing Rare Native Birds, and solar PV privatising generation and making communities more resilient house by house, no, wait, scratch that last one.
  • There is a cost to these externalities.
  • There is a substantial non-construction cost to any replacement plant:  consents, appeals, interest on capital committed, consultants, legal eagles (the ones the windmills didn't get) yada yada.  Ask any backyard subdivider for a full list.
  • Thus historic cost is a Rilly Bad Indicator of replacement cost.
  • So some other value needs to be derived (somewhere between historic, which is clearly inadequate) and replace-it-now (which is clearly not warranted).
  • Hence the rise of Optimised Deprival Valuation - have a gander at This, f'rinstance, and other forms of value determination for major infrastructure.
  • Because, finally, infinite maintenance is not gonna keep all of this generation plant alive........

The real question, I think, is whether an ROI based on That value, is always justified....

MbM, please.
For a moment would you consider that there are utility/regulated assets and non utility/regulated assets..
There is a whole body of work devoted to pricing and valuation of regulated assets. Please google for more.
 

The revenue equation
The revenue equation is an expression which relates the allowed revenue of the regulated firm to the sum of the return on capital (the appropriate cost of capital multiplied by the regulatory asset base) plus the return of capital (also known as the depreciation) plus the operating expenditure (in addition, in many applications of the building block model there are other terms, such as compensation for tax liabilities):

Here: is the target allowed revenue of the regulated firm in the current regulatory period, is the appropriate cost of capital (also known as the discount rate) for the cash-flow stream of the firm during the current regulatory period, is the closing regulatory asset base at the end of the previous period (the product of the cost of capital times the asset base is also known as the "return on capital"), is the regulatory depreciation in the current period, and is the expected or forecast operating expenditure of the firm in the current regulatory period.
The revenue equation is embodied, for example, in the "Post Tax Revenue Model" spreadsheet used by the Australian Energy Regulator.[18]
 

The asset base roll forward equation
The asset base roll forward equation is an expression which relates the closing regulatory asset base at the end of the period to the opening asset base at the start of the period plus any new capital expenditure that occurs during the regulatory period less any depreciation during the regulatory period.

Here: is the closing asset base at the end of the current period, is the closing asset base at the end of the previous period, is the capital expenditure of the firm in the current period, and is the regulatory depreciation during the current period.
The asset base roll forward equation is embodied, for example, in the "Roll Forward Model" spreadsheet used by the Australian Energy Regulator.[19]
The primary reason for using the building block model can be stated as follows: Provided (a) the regulator chooses a path of the regulatory asset base which starts at zero before the firm incurs any expenditure and ends at zero after the end of the life of the firm (or, equivalently, provided the sum of the allowed depreciation each period adds up to the total capital expenditure of the firm) and (b) provided the regulator chooses a value for the WACC which reflects the firm's true cost of capital then the resulting path of allowed revenue given by the equations above has the property that the net present value of the cash-flow of the firm (that is, the revenue less the expenditure) is precisely zero.

Definition of 'Regulatory Asset'
Specific costs or revenues that a regulatory agency permits a U.S. public utility (usually an energy company) to defer to its balance sheet. These amounts would otherwise be required to appear on the company's income statement and would be charged against current expenses or revenues.

Investopedia explains 'Regulatory Asset'
The accounting methods used to disclose regulatory assets may cause differences in how an electric utility company's financial condition is reported. For example, under U.K. GAAP, these assets are currently recorded on the balance sheet.

Under recently developed International Financial Reporting Standards, regulatory assets are not permitted to be recognized on the balance sheet. Instead, costs will be charged to the income statement when incurred, and recoveries from customers will be recognized when receivable.
 
http://en.wikipedia.org/wiki/Building_block_model
http://www.treasury.qld.gov.au/office/knowledge/docs/kpmg-valuation-of-s...
http://www.deloitte.com/assets/Dcom-Australia/Local%20Assets/Documents/I...
http://www.aer.gov.au/sites/default/files/Attachment%209.21%20SFG%20Cons...
http://www.kpmg.com/global/en/issuesandinsights/articlespublications/ins...
 

The key sentence is that if New Zealand converted its electricity regulations to the US or UK systems our Gentailers would face "write-downs could total up to $12 billion, and revenue reductions could be well over $1 billion per year" (achieved by electricity price reductions).
 
Given that the UK and US states do not suffer chronic shortage of electricity supply this clearly indicates there is something seriously uncompetitive about our electricity industry.
 
In a normal competitive industry, say the restaurant sector. You could not take out $1 billion of revenue through price cuts without a massive effect. Say half the restaurants of the country closing down!

This has been well known for a long time , dont act surprized kiwis ooh how unfair .
Its a false business model total rip off, all that rubbish in the media this site also
all the experts blah blah .All the dribble from Joyce and co . Imagine the returns in the
kiwi saver taking a hit oooh. imagine the gst on over the top prices .
All the talk in the media and pollys ooh the share markets taken a hit. The kiwis have been
taking a hit from these vultures for long enough.the fraud thats been going on is under the
noses of John Key and co. also under clark ..But its Legal thats the problem.
Baz
 
 

UK house holds are compalining bitterly about above inflation hikes in energy prices, same arguments kicked aorund there as in NZ as to the reasons behind the price rises, no point in looking to a UK model for a solution.
The problem that Labour will have with its regulated approach as I see it, is the loss of dividend revenue paid to the government from the state owned energy industry,this will have to be made up some where, either from increased taxation or borrowing. Both Labour and National governments have benefited from a revenue source which is not seen as a tax. The insatiable revenue needs of government won't change,  if a few billion is removed from the state owned asset dividend revenue to government, where will it come from? I imagine neither party would be prepared to reduce spending by the equivilent amount! This seems like a blatant vote gathering policy from Labour just like working for families and interest free student loans. These policies are popular due to the broad effect across the economy but must be paid for by some one.
 

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