The Layton paper

If you are actually interested in policy and analysis, rather than slogans, I recommend you spend an hour or so reading the 28 page paper from Electricity Authority Chair Brent Layton. It is a mine of valuable information and analysis. I’ll do a few extracts, but it is worth reading it for yourself.

In the wholesale electricity market, prices are determined by competition between generators offering to supply and these offers being matched to demand. The values of the different generation assets are driven by market prices and not vice versa. The wholesale market is not one in which a regulator exercises price control because it is a workably competitive market with over a dozen grid-connected players on the supply-side and five reasonably large players. There are more major generators in New Zealand than there are major banks, petrol companies or telephone providers. There are, in addition, another 70 generating entities in New Zealand.

With 13 grid connected generators, the challenge is how best to foster competition between them – not haw to remove it.

Regulators are always able to transfer wealth, but if they do so it has to recognise there will be a cost. The cost will be in the willingness and terms on which parties will invest in generation capacity in the future and in other sectors of the economy. Given the size of the expropriation required to raise, say, $500 million a year would be about $7 billion, the chilling effect on investment in New Zealand is likely to be large, widespread and long lived. Either the government will be forced to build future plants (and many other assets) or shortages of electricity (and other services) will be likely.

Labour and Greens seem convinced that generators will invest in new capacity, despite their Government unilaterally setting the price they will be able to sell at. So I have a solution. Why don’t they set up a generating company, go to a bank and borrow the capital needed, and set up their one generator.  With a guaranteed rate of return, how can they lose out?

Firstly, it would require a large bureaucracy and an army of generator staff supported by consultants to determine the appropriate amounts to pay existing generators to cover their operating and capital costs. I estimate that for the approximately 110 generator-class market participants and their 300 plus plants it would take at least 300 analysts and lawyers five years to set up the system ($180 million) and after that 150 people to run it ($18 million a year). A major cost would be working out the opportunity cost value of water in each storage dam.

Maybe this is what they meant with 5,000 extra jobs! Can’t see it leading to cheaper power though!

In addition, the new arrangement would require the central contract buyer and potential investors in generation to have significant expertise and resources to conduct tenders for future capacity. I estimate 50 analysts and lawyers would be required for this at an annual cost of $6 million.

Moreover, there will be a need for extensive negotiations with retailers over their contracts with the single contract buyer and there may also be the need for monitoring of the split between retail and generation activities within the one company. I estimate a further 50 analysts and lawyers would be required for this at an annual cost of $6 million.

Time to become a lawyer!

In South Korea, the central decision maker has struggled to break even and satisfy demand. Industrial consumers were recently requested to alter their  working hours to reduce pressure on electricity capacity. In August 2012 prices for consumers were increased by 4.9% in an attempt to reduce demand and return the sole buyer to profit. In January 2013 prices were increased on average by a further 4%

But they are one of the model countries!

Secondly, in 2004 the government introduced a requirement that retailers provide a low fixed charge option to customers, such that residential consumers using less than 8,000 kWh a year pay less on this option than they would on any other corresponding option. This regulation effectively requires a cross-subsidy from all high use consumers to low use consumers receiving the low fixed charge. The data upon which the residential price trends are based relates to the cost of electricity to residential customers using 8,000 kWh a year.

As more and more low use consumers took up the low fixed charge tariff option as time went by it was almost inevitable that the reported price of electricity to residential customers consuming 8,000 kWh a year would rise as retailers set standard charges to offset the increasing level of subsidies required under the regulations.

This is a key point. Part of the reason why most people have had power prices go up, is because of the Govt mandated subsidies for some users. And Greens are proposing many more subsidies – ones that will ultimately be funded by those who are not eligible for them.