An Open Letter to David Shearer and David Parker

By Seamus Hogan 22/04/2013 10


Dear David and David,

I have read with interest the policy document you released yesterday: New Zealand Power, Energising New Zealand. I wonder if you could clarify a few points for me.

  1. In the document and the associated speeches, you quote the Wolak report’s figure of $4.3b of, in your words, “super profits”. Have either of your read the report, or any of the trenchant criticisms of that report? (A bit egotistically, I can suggest work that I was involved in, here, here, and here, but there are others.) 
  2. You say that “prices are rising faster than in many of our major competitor countries”, and show a graph comparing the price trend in a number of countries since 1986. Let’s leave aside the question of what is meant by “competitor country”. Is it your position that prices were correct in New Zealand in 1986? Elsewhere you say that your new agency, New Zealand Power, will set prices based on operating costs and a fair return on capital. Is it your position that prices were generating a fair return on capital in 1986?
  3. You say that the faster rate of price growth in New Zealand “undermines the competitiveness of our economy”. But one of your graphs shows that real industrial prices have remained about constant since 1986 and commercial prices have fallen. What exactly do you mean by “competitiveness”? 
  4. Your graph shows that the faster increase of prices relative to other countries has been fairly steady since 1986 albeit with an acceleration around 2000. Since your explanation for this price trend is a lack of competition in the market and the use of marginal-cost rather than average-cost pricing, is it your position that these factors have been changing steadily over the past 25 years, accelerating during the period of the last Labour government? Is it possible that the trend might be attributable to steady increases in demand over time and regulatory obstacles to power companies building new capacity? 
  5. You say that selling assets will “push up power prices even more as foreign and corporate investors look to maximise profits”. Is it your position that the state-owned electricity companies are not currently looking to maximise profit, even though that is their fiduciary duty under the State-Owned Enterprises Act? 
  6. You state that the Wolak report found that the four big generators made “super profits of $4.3b at the expense of consumers”. You also state that hydro generators earn “super profits” by using free water to generate electricity that is sold at the same price as generators using more expensive methods. Do you think this is what Wolak meant when he calculated the excess profits earned? Have you read the Wolak report? 
  7. As I noted earlier, you state that price will be set based on operating costs and a fair return to capital. But the Wolak report assumed that there was excess capacity in New Zealand so that a competitive market would have produced prices based only on operating costs. Are you stating that Wolak’s $4.3b figure is overstated? Have you read the Wolak report? 
  8.  Drawing on a report you have commissioned from BERL, you state that your policy will create 5,000 jobs and boost the economy by $450 million per annum. In their report, BERL state that they are assuming an economy with deficient demand so that unemployed resources are avaialbe to the industrial and commercial sector with no opportunity cost. In citing that figure as an on-going per annum benefit, are you stating that it is your view that the economy will remain in a state of deficient aggregate demand forever, and that your government would take no other action to increase demand? 
  9. And if you have time, could you ask BERL whether it is not an oxymorn to have a computable general equilibrium model, and then state that “the model’s calculation of the impacts on the government accounts exclude the direct loss of revenue from lower generator dividends and lower tax receipts from the generator’s reduced profits”. 
  10. By the way, did you know that one of the implicit assumptions Wolak used in his report implied that there was no efficiency loss from the putative overcharging, just a transfer from users to taxpayers? If you accept this report, wouldn’t it be easier just to use the tax and benefit system to transfer money back to poorer consumers? Have you read the Wolak report?
Kindest Regards….


10 Responses to “An Open Letter to David Shearer and David Parker”

  • “5. You say that selling assets will “push up power prices even more as foreign and corporate investors look to maximise profits”. Is it your position that the state-owned electricity companies are not currently looking to maximise profit, even though that is their fiduciary duty under the State-Owned Enterprises Act? ”

    No its not. From the Act:

    “4 Principal objective to be successful business
    (1)The principal objective of every State enterprise shall be to operate as a successful business and, to this end, to be—
    (a)as profitable and efficient as comparable businesses that are not owned by the Crown; and
    (b)a good employer; and
    (c)an organisation that exhibits a sense of social responsibility by having regard to the interests of the community in which it operates and by endeavouring to accommodate or encourage these when able to do so.”

    I am having difficulty finding “maximise profits” in this clause.

    I once owned a stake in the Hutt Valley Power and Gas Board. It was “worth” $1500 to every account holder. We were assured that “we” would continue to own it.

    I have been screwed once. The electricity business as it is setup sure as hell ain’t following Clause 4.c!

    Oh..and lets not forget Max Bradford’s hollow promises highlighted by your colleague Bill Rosenberg:

    “Energy Minister Max Bradford claimed that promoting competition in the electricity sector would bring price reductions, with gains flowing through to household and small business consumers. He identified long-term efficiency gains as the objective of the reforms (Bradford, 1998).”

    and

    “As Bradford explained proudly to an Asia Pacific Economic Cooperation (APEC) meeting of electricity business interests in 1999, New Zealand offered “excellent investment opportunities” through its predictable and transparent regulatory framework and its lack of restrictions on foreign ownership. New Zealand had no electricity industry regulation or regulators, and relied on the general competition law set by the Commerce Act. “Above all”, he said, New Zealand has “no formalised ‘energy plan’” (Bradford, 1999). Security of ongoing electricity supply would not be a problem because Bradford believed competitive conditions and accessible information would solve everything: “Rising electricity prices will act as an early warning mechanism of an impending shortage,” and these “better price signals” will assist all, generators, retailers and consumers alike, to manage their “future supply risks”.

    We were sold a pup. I have a suspicion we won’t accept the dog being put up this time.

    http://www.converge.org.nz/watchdog/08/06.htm

  • Ross, I think that 4(c) is more to let SOEs sponsor community organisations and that kind of thing. They still have to earn a profit comparable to private sector firms in 4(a).

    I’m also pretty sure that a few attempts to increase power generation were batted back; the generators tried to respond to the price signals.

    Where supply is tight, doesn’t it make more sense that heavy users pay more, everyone pare back their consumption, and that the SOEs return that higher profit as dividend than that we fix prices at some lower level, induce higher consumption, and risk brownouts?

  • “I am having difficulty finding “maximise profits” in this clause.”

    What about 4(a)?

    (a)as profitable and efficient as comparable businesses that are not owned by the Crown

    Now if private companies maximise profits, and the standard assumption is that they do, then by 4(a) SOE’s have to maximise profits.

  • so, where is the incentive to pare back consumption or, lord help me, become a nett contributor by applying micro-generation systems?

    There seems to me to be an inherent overarching problem with the commercial delivery of electricity, and its this. The only bit of the market that adds value to me is the retailer. This is the only point where a differentiated product can be delivered to me. All the rest is a natural monopoly or at best oligopoly.

    And currently, every part of the supply chain is wedded to selling me MORE electricity, not less.

    Lets start by admitting that I cannot easily opt out of electricity. Sure, it can be done, but the capital cost is significant and it requires a level of knowledge and commitment that most consumers just don’t have. So the suppliers have a natural advantage – I’m screwed, and have little to no bargaining power.

    I can’t even realistically choose the source of generation – if I am, for example, adamantly against fossil fuels, I have no way of making a market statement by purchasing only “ethically generated, non-fossil fuel” electricity.

    I get charged the same for the first kw as for the last. In fact, my cost per kw actually increases the less I use, because the line charge becomes an increasingly large component of the cost. Ask anyone supplied by The Lines Company.

    Worse, it is in the generators’ interest to maintain a shortage of capacity. Just a couple of % will do it. This ensures their return for every watt generated is maximised (especially with the current madcap pricing model), but there is not quite enough shortage to justify a new generator stepping in. So supply can be PERMANENTLY tight regardless of actual capacity and generators can ultimately make more profit by not generating that last kw than by generating it…

    Apart from noting it, lets not go to the issue of capital revaluations throughout the electricity sector that have allowed accounting gymnastics to overleap reality.

    It is in the retailers interest to sell as much electricity as possible to as few customers as possible. It is not in the retailers interests to allow for micro-generation or any other situation where the consumer is in total and informed control over their electricity consumption based on real-time pricing signals. If it were, they would be providing for it as the technology exists.

    Meanwhile, the transmission sector is driven to minimise the quality of its infrastructure as it gets no advantage from excess capacity.

    So, natural monopolies are delivering an undifferentiated commodity to a consumer who lacks any significant capacity to make real market decisions.

    Thats a damned odd definition of a market.

  • I read 4c as being “socially responsible” as not gaming or ripping the system off. They fail that one.

    Eric: “profitable and efficient as comparable businesses” is far from maximising profits. I read maximising profits by SOEs as being socially irresponsible. But i am sure we will disagree.

  • “Eric: “profitable and efficient as comparable businesses” is far from maximising profits.

    If the other, private, firms are maximising profits then by 4(a) SOEs must also be maximising profits.

    “I read maximising profits by SOEs as being socially irresponsible. But i am sure we will disagree.”

    In what sense? Using resources inefficiently seems more socially irresponsible.

  • Looks to me, Eric, you have been on this case before:

    http://offsettingbehaviour.blogspot.co.nz/2011/11/justification-for-partial-asset-sales.html

    “Anonymous” replies to the piece which explains the “efficiencies” quite nicely. He says:

    “Let’s test this idea against what happened in the dry year in 2008.

    Genesis Energy’s earnings were boosted by the high prices caused by the dry year. Its EBITDAF in 2008 was 90% higher than 2007 and 65% higher than in 2009. What’s the impact on a company’s share price of a one-year boost in EBITDAF of up to 90%? I’m guessing not a huge amount.

    What’s the impact of a dry year on an otherwise unhedged retailer? Let’s make up some rough numbers: in a normal year the retailer buys electricity at say $80/MWh and targets a gross margin of says $20/MWh, i.e. it sells to its customers at $100/MWh (plus local lines charges). The retailer’s net profit is $20/MWh less whatever its costs are.

    In a dry year like 2008 wholesale prices can easily go as high as $300/MWh for an extended period. So that $20/MWh gross margin suddenly becomes minus $200/MWh, and the retailer is burning through its cash at a fairly rapid rate.

    For every MWh of electricity that the retailer was selling, what percentage of Genesis Energy would it need to own to be able to survive this?

    Second problem – let’s say the retailer wants to compete in Christchurch. The dominant generator in the region is Meridian, as it has 6 out of the 8 hydro stations on the Waitaki river. By your criteria it is the correct company for the retailer to buy shares in.

    What happened to Meridian in 2008? The output from its hydro stations went down because it was a dry year. Meridian became a net purchaser of electricity, at very high spot prices, and so it made significant losses. If Meridian had been partially listed, its share price would have gone down. So it would not have been a very effective hedge.”

    Purely and simply, hedging is gambling. And it is being played with our money. We end up paying regardless. It is the clipping in the middle that gets up my craw and to suggest this is “Efficient” is BS.

    The. Electricity. System. Is. Insane.

  • @ Ross. A few points in reply:

    1. Your interpretation of the wording of the SOE act is not they way successive governments have interpreted it. Wolak himself stated that the SOEs, to the extent that they can withhold supply to increase profits would be following their fiduciary duty.

    2. Max Bradford did not design the electricity market, he simply oversaw the design by experts in the area. They told him quite explicitly, that the purpose of the market was to slow the inevitable increase in prices that was gong to occur, and that he should not say that the reforms would “lower prices”. Bradford, mistakenly in my view, decided that “slowing an increase” was to complicated compared to “reducing”, but to use Bradford’s exact words to claim that the reforms have failed is just political rhetoric and Bill Rosenberg should know better.

    3. On the justification for partial asset sales, that was my post, not Eric’s. It was just a bit of fun trying to see if I could rationalise what pretty much all commentators see as a crazy policy–selling off a minority stake. Some think we should sell off 100%, others, like me http://offsettingbehaviour.blogspot.co.nz/2009/07/should-meridian-be-privatised.html have argued against.

  • @ Ashton.

    1. You don’t pay more *at the margin* the less electricity you consume, just more on average. It is the marginal price that gives you the incentive to use or conserve.

    2. Under the current model, the retailer has every incentive to have you consume less at a time when supply is scarce, since they are selling to you a fixed price that is lower than the current spot price they are paying on the wholesale market, an incentive that exists (mostly) even if they have a net positive position in the generation market. In contrast, under a model where retailers by at a fixed price from a government agency, there would be no incentive at all for retailers to encourage less use by customers.

    3. No you can’t choose the source of generation, and you will never be able to as long as electricity gets piped into a single grid. Would you really want us to invest in having separate transmission system from every generator to every household, just so consumers could choose how their power was created?

    4. If generators have a net positive position in the market (i.e. their generation market shares are not balanced by similar retail shares), they do have an incentive to withhold supply to inflate price, but if their net position is close to zero (as has become the case), that incentive is very small.

    5. And no, there is not much incentive to invest in new generation, as the marginal plant is expensive, and likely to be used only during very rare peak periods (a combination of low rainfall in the southern lakes and high winter demand). Until such time as we get more flexible retail prices responding to market conditions (which having a single wholesale buyer makes less likely), we can’t escape the fact that we are not paying enough for the marginal unit of power to cover the costs. That isn’t a problem with the market; it is an unfortunate fact about NZ’s geography. And even so, Meridian has made several attempts to expand capacity but failed at the resource consent stage. You can’t blame the market design for that.