THE RISE AND RISE OF POWER PRICES
16 October 2008What's driving the big increases in electricity prices? Nick Smith investigates
After three years waiting -- and five years in which electricity company profits rose an average 21% a year -- New Zealanders will soon discover whether the Commerce Commission has unearthed enough evidence to prosecute for abuse of market power.
But even if the commission says such evidence exists, what can be done to ensure prices don't keeping rising? One solution, energy market experts contend, is to stop the State-sponsored money-go- round that has coloured the electricity supply regime since Labour took power in 1999. They say electricity State-owned Enterprises (SOEs) are being used as cash cows for massive government spending. In effect, government-owned firms are cranking up household power bills and the Government is recycling the cash through schemes such as Working for Families.
Crown Company Monitoring Unit figures released last month show nearly $4 billion in profits have been made by the SOEs (Transpower, Meridian, Genesis and Mighty River Power) since 1999, with more than $2.6 billion being stripped out in dividends by the Government.
All have earned high rates of return on assets employed relative to their risk, but the killer, which feeds into power prices, is the Government has required regular revaluation of the SOEs' assets.
Because a required rate of return is payable to the Government, this means prices charged by the generators and Transpower have had to increase regularly. And, if you look at the veritable explosion in electricity prices since 2001 -- when the Labour Government began regulating the industry -- they have.
The Commerce Commission expects to publish within two weeks an initial report on its investigation into electricity retailers, started in August 2005 and focussing on whether any of the big five energy companies -- the SOEs Meridian, Mighty River Power and Genesis, plus Contact and Trustpower -- used a "substantial degree of market power for an anti- competitive purpose".
"The inquiry could potentially lead to prosecution and it doesn't surprise me it's taken this long," says Ralph Matthes, Major Electricity Users Group executive director. "We're potentially talking about companies having market power and abusing it, either individually or collectively, so you can imagine the amount of analysis required to provide a clear-cut yes or no recommendation to go to court."
There's a fair bit more territory to cross before we get a day in court but commission chairwoman Paula Rebstock acknowledges "there is a high level of interest in the state of the New Zealand electricity industry".
Consumers have more than a little interest in the matter -- each year the price households pay for electricity goes up by substantial amounts. Prices rose a staggering 16% over 12 months in 2006 alone.
Now Contact Energy wants to charge an extra 10% to some customers, sparking the usual impotent furore among politicians. Energy sector analysts, such as ABN Amro's Rob Foster, predict all generators will raise consumer prices in the next 12 months.
Meanwhile, the cost to big industrial users is flat or declining, while commercial users are paying only a little bit more.
"I'm not sure they're ripping us off blind," says Sue Chetwin, Consumer New Zealand chief executive, "but ordinary consumers are paying way more. The basic problem is there isn't enough competition in the electricity market."
David Caygill, chairman of the Electricity Commission, charged with regulating the industry, bridles at the lack- of-competition accusation. New Zealand has five major generator-retailers servicing four million people; the United Kingdom has six for a population of 61 million, he points out.
Retail choice can be limited outside urban areas, Caygill says, but customers always have a choice.
But he agrees there is no cogent explanation for the extent of price rises residential customers have had to pay.
"Prices to residential customers have increased significantly more than prices to commercial and industrial customers. Residential prices have skyrocketed."
The removal in 1993 of incentives to cross-subsidise household electricity is no longer a valid argument, Caygill argues, but he won't accuse the industry of any wrongdoing without evidence.
International comparisons are important. Compared to the Australians, the margin New Zealand generators enjoy is at the upper end of what would be expected across the ditch.
The system works, he says, in keeping pressure on production.
"It doesn't look all that flash, however, in keeping pressure on what I call retail margins," Caygill concedes. "[The data] doesn't say, 'whoop, whoop, pull up, we're doing something stupid here'."
It does say we're less competitive than the hydro-less Australians: "It's not just on the sports field I'm sick of getting beaten."
The problem he and the commission face is the electricity system is opaque.
"They have very little information that suppliers must publish," Matthes explains.
Some electricity experts say smart metering is a solution to the opacity, which is only now being acted on by some companies. A smart meter gives consumers much more information on prices in the wholesale markets. Once retailers offer appropriate pricing packages, the theory goes, consumers will be able to control their demand or pick lower prices.
"It should have happened years ago," one commentator said.
Part of the reason it's taken three years for the commission's Frank Wolak, Stanford University economist and global electricity specialist, to publish an interim report is the difficulty in gathering information in a form that can be compared.
Power companies are also noisy about the regulatory landscape and its cost to businesses.
Contact Energy, for example, argues a 10% increase in the cost of electricity is justifiable because of the hit it took during the drought and its commitment to spending on new energy projects, not to mention the extra cost the Emissions Trading Scheme. All of which is true. This year's drought saw the company's profit nearly halve to $129 million. But Matthes says Contact's future spending argument "doesn't happen in real commodity markets".
"If you're selling aluminium, you can't increase today's prices by saying the long- run marginal cost of producing aluminium is going through the roof.
"Electricity could hardly be called a highly competitive commodity market."
It is, in fact, a non-tradeable commodity everyone has to buy and is a big contributor to New Zealand's inflation problem.
Look at the profits of the Big Five between 2002 and 2007: annual average growth is more than 21%.
Energy sector profit growth is the envy of other industries and, Matthes says, "should be a great big signal to other people to get stuck in".
Big money is involved and is, suggests Caygill, a disincentive to a crowded market. Look to the lousy rate of return on capital that energy companies generate, he says. But it is also true that energy companies are highly profitable and the value of their assets are rising rapidly, particularly for those with a large hydro portfolio. In other words, the rate of return is a poor indicator of investor value and, if more evidence was needed, market analysts are long-term bulls for energy stock.
Alan Jenkins, Electricity Networks Association chief executive, says one reason for residential price rises is companies exploit the infrastructural and weather constraints to manipulate the spot market.
Other causes include the lack of reserve energy capacity in a weather-dependent country and the difficulty in changing electricity providers.
About 10% of residential users change providers each year. Most of them, say Jenkins, Matthes and Chetwin, are changing home, not making choices. People can decide to change but good luck to them on making heads or tails of the choices.
As Jenkins notes, such is the plethora of options, it's impossible to make a price comparison.
Compulsion on price comparison, says Caygill, is an option, as is forcing lines companies to standardise contracts with generator retailers. The industry will hate it but, to his mind, all options to reduce household power prices are on the table.
Reserve capacity requirements are also an option, including paying generators to maintain excess generation capacity. The commission is proposing a 17% overall reserve for the country and 30% for the vital South Island catchment.
The thinking is reserve requirements will smooth out extreme peaks in the wholesale market.
"Our energy prices have gone from the lowest in the world to among the highest," says Jenkins. "You have to take it back to how the market is structured around the spot market.
"We've had five winter shortages in eight years, which tells you there isn't enough reserve. People are saying, why should we build more capacity when we can make a fortune out of shortages?"
(c) 2008 The Independent Business Weekly
The Independent Financial Review
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