Will the NZ Power proposal actually reduce electricity charges? Geoff Simmons looks it over the longer term, and the alternatives

By Geoff Simmons*

The Labour/Greens have made no secret of their proposal to reform the electricity sector, announcing the NZ Power plan over a year ago during the asset sales process.

National’s approach is more of the same – gently encouraging more competition in the electricity market.

The question is which will lower your power bill?

The short answer is that the Labour/ Green proposal would probably work and power prices would drop – at least in the short term.

The real question is what would happen to power prices (and power supply) in the long term.

That is where the Labour/Greens proposal falls short compared to National’s status quo.

However, there are ways to lower power prices and even raise extra cash for the government.

How are power prices set now?

There are many links in the chain of getting power to your house:

1. the generators make the power;
2. the national grid Transpower and the local lines companies transmit the power; and
3. finally the retailers sell it to us, the consumers.

They all point fingers at each other over rising power prices, and it can be hard to tell who is telling the truth as some companies own different bits in the chain (the big generators are also the big retailers).

According to the Ministry of Business, 90% of the recent price rises are actually due to the line companies, however this is disputed by the lines companies themselves. The Labour/ Greens plan focusses on the generation side of things, so lets start with that bit.

How Are generation prices set?

Labour and the Greens are right in pointing out that hydro power generators get paid a lot more for the power they generate than it costs them to make. Hydro is cheap to run compared to most other forms of generation. In the old days Electricorp and its predecessors only charged for power based on the cost of generating the electricity. This meant that we all got the benefits of cheap hydro power.

Nowadays the price is set differently. The price for all the electricity we buy is based on the cost of the most expensive source of power used (usually a gas or coal fired power station). As a result, prices are higher than in the old Electricorp days. However, like most markets this price sends the right signals to consumers and generators. If consumers are willing to pay the right price, generators will build new power stations (such as wind turbines). If the price of power is too high, consmers will not use the power. The result is that we as a society, use and generate the optimal amount of power.

So are we being overcharged?

Labour and the Greens now think it is unfair that the private power companies can use the dams our nation built and water that (supposedly) nobody owns to generate cheap power and sell it at a profit. Let’s be clear though – shareholders bought those companies at the going rate. The sale price for the power companies was higher than it cost us to build the dams in the first place. We, the taxpayers, pocketed the difference. Given that windfall, it is a bit rich to turn around and say we are being overcharged for hydro power.

There have also been claims of price gouging in the electricity sector, but there is no proof of this. We’ll talk more about the transparency of the sector later.

NZ Power

The Labour/ Greens solution is to put a government buyer and seller of power – NZ Power – between generators and retailers. They would pay the generators based on the cost of generating the power – so hydro generators would receive a lot less money than they do now. These savings would be passed on to consumers.

Lower power bills sound like a win for the average Kiwi, but it comes with some long term risks.

Risks with NZ Power

At the moment prices help the generators decide how much electricity to generate, and whether it is worthwhile investing in new power generation. 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:

• Skimp on generation and you get shortages;
• Overinvest and power prices will end up higher than they should be, in order to pay for the extra generation capacity.

Shortages look bad, so in most countries where the NZ Power approach has been tried,conservative government officials tend to build more power stations than they need, just in case. Lower prices would also increase the demand for power, reinforcing the need for more power stations. Under the NZ Power model all power stations would fetch a fair return, so that is a recipe for higher prices in the long term.

Building more power stations would also have an impact on the environment, which is strange given the Labour Greens stance in this area. All power stations have an environmental impact when they are built – even wind.

Is there an alternative to NZ Power?

The Government has been focussed on improving competition in the electricity industry, and it could continue to do so. As mentioned above, the electricity market is still a little murky. We have five large power generators, which are also the main retailers. By generating and selling electricity the big players are better equipped to handle ups and downs in the market. For example when the hydro lakes are low and electricity prices are high, generators do well and retailers get hammered. In years where the hydro lakes are full, the opposite happens. The advantage of owning both is clear, but does that give them market power? We don’t know.

We could find out through a hedge market, which is why the Government recently created one. This is a market where generators sell future power packages to retailers. In theory this allows new retailers and generators to enter the market and have some long term certainty about electricity prices. This means that independent generators (including for example households or communities with wind turbines) and retailers can enter the market without fear of being stomped on by the big guys.

This hedge market is growing, and needs to keep doing so to allow new players to enter the market. Either Labour/Greens or National could simply say that if the big generator/ retailers are dragging their feet, they would force them use the hedge market for all transactions. That should make it clearer if anyone is price gouging.

What about free water?

We agree that it is unfair that hydro generators use public water for free. That is why we have suggested charging all commercial water users, including farmers. In fact, Labour and the Greens are both suggesting a water charge on farmers as a separate policy.

The advantage of a water charge over NZ Power is that it would leave the electricity market in place. It 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).

Even Labour seem to have acknowledged that this would be a more efficient solution, but have stuck with the NZ Power model because lower power prices help them score political points.

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

• Charge hydro generators for the water they use (this wouldn’t affect the price as the cost of generating hydro is so much lower than it is for other generation types)

• Keep growing the hedge market to improve competition (this should drop the price)

• Hurry up and close Tiwai, which should drop electricity prices by 10%, plus save the Government any future bribes (such as the recent $30 million payout to Rio Tinto).

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Geoff Simmons is a senior economist at the Morgan Foundation. This article was first published on the blog garethsworld.com and is re-published here with permission.