Dr Oliver Hartwich: Splitting power generators from their retail arms would not cut electricity bills

With energy prices spiking, an old idea has gathered fresh momentum: break up the big electricity companies. New Zealand First put the proposal on its agenda at the party’s State of the Nation address, calling for the four gentailers, companies that both generate and retail power, to be split apart.

When people are hurting, the urge to do something is understandable. But doing something is not the same as doing the right thing. I should disclose that several gentailers, and Chorus, are members of The New Zealand Initiative, which I run. But the case against splitting them depends on economics, not loyalty.

The logic often used to justify the proposal is borrowed from telecommunications: Telecom agreed to separate into Chorus and Spark as part of the government’s ultra-fast broadband deal, and broadband improved, so the same medicine should work for electricity. It is a tidy argument with one problem. It is wrong.

The Chorus split worked because the fibre network running to your house is what economists call a natural monopoly. It makes no sense to dig up the street and lay a second set of cables to the same address.

Separating that single network from the retail companies and regulating access was therefore sound economics. Once Chorus was independent, any retailer could offer broadband over the same wires on equal terms.

Electricity generation is nothing like this. Multiple generators already compete to produce power using hydro, wind, geothermal and gas. The transmission grid is already separately owned by Transpower, and the local lines companies were split from generation and retail back in 1998.

The proposed split would not separate a monopoly from a competitive market. It would separate two competitive activities that sit together inside the same companies for a reason.

That reason comes down to a feature of electricity that makes it unlike almost any other product. It remains costly to store in quantities large enough to keep prices stable. Prices swing wildly depending on rainfall, wind, demand and the time of day.

A retailer buying all its electricity on the spot market faces enormous risk. When wholesale prices spike, as they do in dry years, a standalone retailer must either absorb crippling losses or pass the full shock straight through to customers.

Economists have a name for this: vertical integration. It is a classic response to markets with wild price swings, a way for companies to protect themselves from volatility they cannot control.

A simple made-up example explains how it works. A farmer grows wheat and runs a bakery. When wheat prices spike, the bakery pays more for flour, but the farm earns more from selling grain. The two balance each other out but split them into separate businesses and bakers are fully exposed to price spikes with no cushion.

That is what a gentailer does. By combining generation and retail under one roof, the company absorbs its own price shocks. When wholesale prices rise, the generation side earns more and the retail side pays more, which can mean smoother bills for consumers.

Split the companies apart, and standalone retailers would need to replace that cushion with expensive financial contracts, costs they would pass on to households.

There is a reason the idea appeals. Households look at their power bills and see four companies all charging roughly the same thing, and they assume the similarity means a lack of competition.

But in a competitive market, prices converge. That is what competition does. If one company could profitably undercut the others, it would, and the rest would match. Similar prices are not evidence of a cosy oligopoly. They are the result of competitive pressure.

None of this means the electricity market is perfect. But dismantling the companies operating in it will not make it better.

The real problem is elsewhere. Most households never switch. They stay with whoever they signed up with years ago and do not shop around, even when better deals are available.

I should know. I am an economist and I have never switched my electricity supplier. I tell myself I am happy with the one I have, and I suspect I would not save much by switching. The economist in me justifies the inertia by suggesting that my search and transaction costs would exceed the benefit.

I am, in short, exactly the kind of consumer who makes the electricity market look uncompetitive even when it is not.

Splitting the gentailers would not change this. You would still have the same inert consumers, just choosing between smaller, less financially resilient companies.

Powerswitch has existed for years and the Electricity Authority has just launched a second tool, Billy. Yet too few households actively compare plans or switch. Shifting consumer habits is hard, but it is less destructive than dismantling companies that are managing price risk on behalf of their customers.

Political activism on energy market restructuring is not a New Zealand oddity. The European Union has pushed its member states to separate their electricity markets for decades. The results strongly suggest that such structural interventions have not reduced prices for consumers.

Anyone genuinely interested in reducing electricity costs should ask a simpler question: why do so few households switch?

The answer is less dramatic than splitting four companies. It is also more likely to actually reduce someone’s power bill.

Dr Oliver Hartwich is the Executive Director of The New Zealand Initiative think tank. This article was first published HERE