Bryan Leyland: “Things you know that ain't so - our electricity market is efficient and benefits consumers”

“Things you know that ain't so - our electricity market is efficient and benefits the consumer”

When you look at it closely, the electricity market and the associated reforms are riddled with problems that have massively increased costs to consumers.

The first problem is the belief that a market selling kWh on the spot market is efficient.

In general, efficient markets deal in commodities that have price elasticity – when the price goes up the demand goes down – and for which there is an alternative good – if baked beans are too expensive you can always buy spaghetti. In fact, the electricity market closely resembles the oil “market” that has had its price set by OPEC for years. Like electricity, there is no alternative good and the value is greater than the price.

The main differences are that, unlike electricity, oil can be stored and it can be traded internationally. When we are close to a shortage the generators can set the price. Which they do. When we have a surplus of generation, they shut down power stations to bring us back to being on the edge of a shortage. Which they are now doing.

The electricity market has brought windfall profits to hydropower generators at the expense of the consumers. When the market started, the overall cost of generation from hydropower stations was in the vicinity of 3 cents/kWh. As a result of the market they suddenly were being paid the cost of generation from thermal stations – about 6 cents. A few years ago I estimated that this cost the consumer in excess of $4 billion.

The profits have been partly hidden by progressively racking up the asset value by a factor that is now close to 3. As a result, they can say that the return on asset value is normal for the type of business and, therefore claim they are not making windfall profits. The Electricity Authority insist that there have been no windfall profits.

Another major problem is associated with our ripple control system. Before the electricity reforms all storage water heaters were controlled by a ripple relay that the lines companies used to limit peak demand and hence reduce Transpower charges that were, quite properly, charged on peak demand. It also brought massive savings in the distribution system because it did not need to be built to supply the unrestricted peak demand and it also saved the cost of building power stations to meet peak demands. The consumer benefit was enormous.

The people who drew up the regulations did not understand this and decreed that the lines companies must pass through all Transpower charges. This meant that they have no income to cover the cost of maintaining and upgrading their ripple injection system and controlling the system load. So most of them let their ripple control system run down and, instead, reinforced their systems to meet unrestricted peak demand – an occupation that, under the Commerce Commission regulations, allowed them to make some profit. So now New Zealand’s peak demand is about 300 MW higher than it needs to be. This has cost New Zealand more than $1 billion because the $900 million 400 kV line from the central North Island to Auckland was needed only because Vector ran down its ripple control system and lines companies would not have spent so much money reinforcing their systems to meet unrestricted peak demand. (The lines companies in the upper South Island are the only ones to have continued with ripple control. It has cost them a few million dollars and saved their consumers much much more.) The Electricity Authority insist that there is nothing they need to do about this. 

Recently a proposal has been made for a new smart water heater controller that could bring even more benefits to the consumer than ripple control because it could be controlled by the consumer, the retailer, the lines company and Transpower to reduce electricity costs. In addition it could reduce the cost of stabilising system frequency and reduce the chance of blackouts due to the loss of major generating plant or a major transmission line. People who understand the power system agree that would bring huge benefits but, with the regulations currently in place, there is no way that anyone can gather all these advantages – probably worth hundreds of millions of dollars a year – together and deliver them to the consumers. So the consumers lose out to market theory.

The New Zealand system gets more than half its electricity from hydropower stations that suffer a significant drop in output in a dry year. Until the electricity market came along, planning to meet the 1 in 20 dry year was a key factor in electricity supply. No longer. The Electricity Authority insist that, in dry year, “the market will provide”. But, when you look at it, the industry will not necessarily suffer a disaster if there are shortages a dry year – one of two gentailers might go broke but others will make windfall profits. So where is their inducement? The damage to the economy from blackouts during a dry year will be enormous and they will be exacerbated by the fact that a political decision was made to shut down productive industries before domestic consumers were asked to make savings. This will increase the costs to the economy. During the last shortage in 2003 – that did not result in blackouts – the damage to the economy was estimated at $200 million.

When Genesis shuts down the Huntly coal fired station in 2018 we will lose the benefits of the dry year reserves in its coal stockpile that amount to about 30% of our hydro storage. We will then be at greater risk of shortages in a dry year than we have been since Meremere station was built in the 1950s. 

People claim that the dry year shortfall can be picked up by geothermal and gas-fired stations but, in practice, this is unlikely to be the case. Geothermal stations normally operate at maximum output continuously so there is little extra they can provide in a dry year. Gas-fired stations are also limited by their gas contracts that demand that they take a constant amount of gas. Some extra gas will probably be available if power prices go up to the extent that the methanol plant is prepared to shut down and sell its gas for power generation. But what price will be needed to persuade it to cut back production, cancel ships already on the water and the like? Probably the best hope is shutting down the aluminium smelter. But if the restart costs are too high it just might stay shut down. Huge economic damage to Southland.

If we do get shortages, it is not at all clear how the electricity market will cope. It does not seem to have any mechanism for coordinating the system, stabilising the power prices and efficiently rationing the limited electricity supply. If they suddenly find that this is necessary then regulations will be brought in hastily that will turn out to be far from perfect.

So what can be done? The ideal situation would be to have a truly independent and wide ranging look at the whole electricity market and reforms from the point of view of consumer benefit, rather than the benefit of the market participants. But, to do this, the politicians would have to accept that the existing market was less than perfect and had served the consumers badly. There is little chance of this happening. 

But if it did happen, there reasonable chance that they would recommend in favour of the single buyer market that was originally recommended to the Wholesale Electricity Market Development Group as the least risky option – and rejected by them. If it could be implemented and kept out of the political interference that was a fundamental part of the Labour/Green parody of a single buyer market it would certainly solve most of the problems – maybe all of them.