Fallow on power

Brian Fallow writes at NZ Herald:

The Labour Party probably regrets invoking the work of Professor Frank Wolak when making the case that New Zealand’s electricity system is broken and in need of a radical overhaul.

Announcing its policy alongside the Greens in April it cited as evidence that the electricity market is not competitive “a 2009 report by international expert Frank Wolak which concluded that between 2001 and 2007 the four big generators extracted super profits of 18 per cent ($4.3 billion) which came at the expense of higher prices for consumers”.

Having put those words in the Stanford economist’s mouth, Labour’s finance spokesman David Parker got to hear him spit them out, when he gave a lecture to the Victoria University’s Institute for the Study of Competition and Regulation in Wellington last week.

Wolak also made it clear he is no fan of cost-based systems such as Labour is peddling, where – instead of a market where generators offer power at whatever prices they see fit – the system operator, armed with a mathematical model and the technical specifications of the various generating units, decides which will run at any given time.

In fact he called their policy a sham. Now many people have called it a sham – but when the person calling it a sham is the man whose work is quoted as the rationale for the policy – well that is devastating.

So what about an alternative cost-based system, adopted in several Latin American countries, where instead of generators competing to be dispatched on the basis of the prices they offer, the system operator decides which will run and what the spot price will be, based on its information about various units’ variable operating costs?

The difficulty with this in a predominantly hydro system is deciding what the opportunity cost of water is in any given dam at any given time, that is, what future value is forgone by sending it through the turbines, and doing that involves trusting the mathematical innards of some black-box model.

One problem is that a key input for such a model is setting a cost of shortage. If it is set too low – and the political pressure is to do that – wholesale prices will be low in normal years but the risk of power shortages in dry years is high.

And many of the countries or states that have such a model are indeed facing blackouts.

Wolak counsels against going that route. It’s far better, he suggests, to make the wholesale market more competitive by making the demand side more responsive to price signals.

“If you are this close to the finish line with the actual market and this far away in the cost-based market, why do it?”

Because you are desperate to win power, and hope it sounds good to the public.

When asked about a single-buyer market, another feature of the Labour/Greens policy, Wolak was dismissive.

If the single buyer simply aggregated the demand that was there anyway, and did not reduce demand in response to higher prices, there would be no competitive benefit, just extra overheads.

So Wolak says Labour’s policy will reduce competition, increase costs and increase teh risk of power shortages. And this from the man they cite as the rationale for their policy. How humiliating.