Guest Post: Response to Bryan Leyland’s Guest Post on 4 October

A guest post by Carl Hansen:

Bryan Leyland has long espoused for a single buyer regime for the NZ electricity market, and so it was no surprise to see him do so again on kiwiblog on 4 October.

Leyland is arguing for a market design that would put the Government in the middle of the supply and demand process. The Government would decide when new generation plant was needed, where they were needed, what type they would be and so on. It would do this by holding tenders and having ministers and government officials decide which offers win the tender.

Rather than focus on consumers, electricity generators would spend inordinate effort to convince ministers and officials of the value of their offer, and in fact they’ll work hard to convince them to hold tenders earlier than when they’re needed and for larger capacity than needed.

Ministers would face great political pressure to cave in to these arguments because the last thing they want to be accused of is running the risk of blackouts. And they’ll be very interested in the location of the plants, and will want to avoid annoying voters in marginal electorates.

In the real world these electricity regimes work very poorly. A single buyer scheme operates in Ontario, Canada. Political pressure during an election campaign in 2011 led the Premier cancelling contracts to build two power plants, which the Ontario Auditor General has calculated will cost taxpayers and electricity consumers $C950 million.

South Korea and South Africa both have single buyer regimes and they’ve both experienced electricity shortages over the last decade. This should be a big red flag as South Korean industry is normally considered very competent.

Leyland is arguing for a regime in which consumers pay prices based on the average cost of all generation rather than the cost of new generation to come onto the market (“marginal costs”). This is the equivalent of trying to defy gravity. We can defy gravity of course, but it requires very expensive rockets and it’s quite a mess when they crash. In simple terms, the average cost approach is very expensive and risky because it messes up crucial investment incentives.

Whatever merits people may once have thought the single buyer approach had, now would be exactly the wrong time to switch to such a regime. The cost of new generation is falling and can be expected to keep falling over the next decade due to reductions in the cost of small-scale generation, such as rooftop solar panels and batteries. If these cost reductions occur then NZ consumers will receive far larger price reductions than what could be achieved under an average cost approach. It is straight-forward in mathematics to show average costs exceed marginal costs when marginal costs are falling.

But the single buyer approach never had a great deal of merit. Leyland implies in his post that consumers have missed out because of the extra profits the large hydro generators earned when the cost of new generation rose. But this is untrue. Those hydro generators were 100% owned by the taxpayer when the wholesale market started in 1996, and they either paid their surplus profits to the Government in the form of dividends or reinvested them. Since then some have been fully privatised (Contact Energy) and some partially privatised. In both cases the government received sale prices reflecting the expected value of future dividends the new owners would receive.

Leyland also claims wholesale electricity prices have increased following partial privatisation, but this is untrue. For example the average price of long-dated futures contracts was $77.18 per MegaWatt-hour in early March 2014 around the time of the partial privatisations and is currently $77.38.

At the start of his post he refers to the 80% increase in residential electricity prices since 1990 but doesn’t mention that prices charged by the competitive component of the market (ie, generation and retailing) are basically at the same level – after adjusting for inflation – as they were seven years ago. The increases in prices for consumers over that time have almost entirely been due to increases in charges from distribution companies. This is a very important fact and is widely known among most other people commenting on the electricity industry.

Carl Hansen has been involved in electricity policy work for over 15 years and was CEO of the Electricity Authority for seven years. He is currently a private consultant at Capital Strategic Advisors Limited.


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