Posted on December 21, 2009

The Minister of Energy and Resources, Gerry Brownlee, this month announced a series of reforms to the electricity market. Taken overall, the reforms are very much targeted at making the “club” formed by the three SOEs and Contact Energy more competitive, but stop well short of a major change in structure of the market itself. The Minister seems to prefer forcing the club to work harder to compete amongst themselves, rather than directly tackling major structural issues, such as the high degree of vertical integration in the market.

For example, the government might have required the major generator-retailers to separate their retailing and generating businesses, forcing participants to manage risks via trading in a much larger and more liquid hedge and contracts market. This option has for a number of years, and despite being an obvious reform, been rejected as being too difficult and disruptive. It might be a more complex option but it would provide new entrant retailers and generators the greatest chance of success, thus promoting both competition and diversity.

Although stopping short of a major change to the structure of the market itself, however, the reforms can certainly not be accused of ‘tinkering’. These reforms will bring about significant changes in the structure of certain market participants, and are clearly designed to introduce greater competition across the country at the retail level. Whether competition results in lower prices than would have occurred anyway we may never know, especially as competition has taken a big step upward this year prior to the reforms. But there are aspects of the reforms that will place greater downward pressure on prices, for example real and virtual asset swaps between the three SOEs. Other aspects will place greater upward pressure on prices, for example the mandatory requirement to reimburse customers during conservation campaigns in very dry years, and the floor on spot prices when conservation campaigns are instituted.

Our comments on the reforms (taken from MED’s summary document) are shown below in italics. We have this mental image of the ETAG, who put the original recommendations in their report, sitting around the meeting table and deciding to include far more recommendations in their report than they ever thought would be implemented. Imagine their surprise when the Minister turned around and said – let’s do them all!

Tekapo A and B power stations to be transferred from Meridian Energy to Genesis Energy and the government-owned Whirinaki plant to be transferred to Meridian Energy.
A complex undertaking given the interconnectedness of the Tekapo-Pukaki-Waitaki hydro system. And given that the SOEs are also required to swap hedge contracts between themselves to support trading away from their respective centres of generation, one wonders why a physical asset swap is necessary. Nevertheless, a positive move to promote more competition in the South Island as Genesis gets their head around operating the two Tekapo stations. It may even promote security of supply if Genesis modifies the operating regime of the Tekapo stations, creating more diversity in the management of key hydro assets.

But you have to wonder what Meridian will do with Whirianki – why would they want such a dog? It doesn’t fit with their renewable branding, it costs a fortune to maintain and run, and it will forever be in danger of being displaced by more efficient gas-fired plant located more strategically. Watch this space – they are likely to sell it, mothball it, or (unlikely) replace it with a gas-fired station in a better location.

Meridian Energy, Genesis Energy and Mighty River Power to undertake ‘virtual asset swaps’ involving one-off long-term (15 year) contracts as follows: Meridian Energy to sell 1,000 GWh/year of ‘South Island’ energy to Mighty River Power, and buy 1,000 GWh/year of ‘North Island’ energy from Mighty River Power. Meridian Energy to sell 450 GWh/year of ‘South Island’ energy to Genesis Energy, and buy 450 GWh/year of ‘North Island’ energy from Genesis Energy.
Now, that’s a real intervention in the market! It will ensure that the SOEs compete for load away from their respective generation centres but it will take some time for them to ‘rebalance their books’ to cover these swaps. In the meantime, plans for new generation may well be put on hold, possibly allowing breathing space for aspiring new entrant generators.

All major generators (with over 500 MW of capacity) to put in place by 1 June 2010 an electricity hedge market with standardised tradable contracts, a clearing house to act as a counter-party for all trades, low barriers to participation and low transaction costs, and market makers (offering buy and sell prices with a maximum spread) to provide liquidity.
We’re really excited about this: it’s not as good as a mandatory split of retailing and generation, but it is a big step in the right direction. The targets the Minister has put in place for liquidity in the hedge market are ambitious and could open up the real possibility of new entry. It should allow a wide range of larger consumers (over 10 GWh per annum) access to a hedge market in which they can have confidence, with prices closer to expected spot prices and the ability to trade out of a bad hedge position (which they can not do now).

Lines businesses to be permitted to retail electricity and construct new thermal generation subject to: corporate separation, transparent and non-discriminatory use-of-system arrangements, and compliance with arms-length rules between businesses, retaining ownership separation between lines businesses and generators with more than 100MW of grid-connected generation, prohibiting lines businesses buying the customer bases of an existing retailer.
This is all very nice, but the real damage was done in 1998 when Max Bradford pushed through the original Electricity Industry Reform Act requiring lines companies to sell off either their lines or their supply business. Prior to 1998 lines companies understood the supply business and were resourced up for it, but now they do not and are not. Some lines businesses will take advantage of the reform, especially around generation, but most will steer clear of retailing like the plague.

Benefits of customer switching to be promoted, including upgrading Consumer NZ’s Powerswitch website (www.powersitch.co.nz), through a three year, $5 million per annum contestable fund.
The poor old customers just don’t seem to get it – there is competition and they have had the ability to get lower prices by switching, for a long time! Oh well, let’s give it another go at getting them to switch.

Introducing more standardised lines tariff structures and use-of-system business rules.
Damned good idea – a relatively small set of standard tariff structures would allow lines companies all the flexibility they need, and vastly simplify the life of customers, retailers and energy consultants.

Introducing a transmission hedging mechanism.
This reform has been on the table for so long I find it impossible to be totally cynical and dismissive of it. In any case, let’s get the hedge market really liquid, then we should worry about transmission hedging. The real reason the hedge market is illiquid is its tiny size, due to vertical integration, nothing to do with transmission constraints.

Releasing all wholesale market bids and offers the following day, and providing for monitoring and analysis of disclosed data.
Why has it taken so long?

Ensuring that guidelines and standards on smart meters provide for (or allow upgrades for) energy efficiency capability, open access communications, customer switching and the development of smart networks.
Not as easy as it sounds from what we understand – expect this to take a long time, and in step with international developments.

Encouraging retailers to make smart tariffs available, as an option for consumers, that provide incentives to better manage electricity consumption.
Great in principle, but do consumers really want this? Recent research undertaken in New Zealand shows that consumers don’t respond to time of use pricing signals. The real benefits of smart meters and smart tariffs will come only as critical mass develops over time, including the ability of smart appliances to respond to signals form smart meters without (once set up) any intervention from their owners: how many of us really want to be running around turning lights on and off in response to electricity pricing signals during the day? In the meantime, there is nothing apart from some metering estimation issues stopping retailers offering tariffs that vary more in line with the probability of a dry year, thus encouraging demand response when it really is needed.

Developing terms and conditions (including pricing guidelines and principles) for purchase of power by retailers from small-scale distributed generation.
Not a moment too soon. DG has been around for a long time, but in the near future the amount wanting to connect to the supply system will increase at a much greater rate than it has in the past. Standards in this area will facilitate the development of DG as a real alternative to large scale generation plant.

Back-up powers for the Minister of Energy and Resources to develop rules on some of these issues if the Electricity Commission (or its successor, the Electricity Authority) does not do so.
Sounds like someone doesn’t have much confidence in the electricity agencies?

Abolish the reserve energy scheme (and transfer Whirinaki to Meridian Energy (see 1)).
It might have worked OK if Whirinaki was built in a better locatoin and using natural gas. But the reserve energy scheme clearly has to go: it was a knee-jerk reaction to a dry year event and was never fully thought through.

Require retailers to make payments to consumers in the event of a conservation campaign or dry year power cuts.
This is a kind of mandatory hedge contract with your customers. Two problems however, the first being that profligate consumers who run their heaters with the doors open look like they’ll be paid extra during dry year emergencies (a minor detail?). Second problem is that new entrant retailers won’t be too happy about taking this risk when they have no control over it. Oh dear, we’re about to make it harder for new entrant retailers.

Put a floor on spot prices during a conservation campaign or dry year power cuts.
Likely to put upward pressure on prices (but you would expect that in order to get greater security of supply) and will have unintended consequences unless very carefully designed.

Require all generators to disclose information relating to supply risks and management of risks.
The more transparency the better, especially in support of a more liquid hedge market.

Review whether, and if so how, terms and conditions should be set for access to water below current consent levels in Lake Pukaki and Lake Hawea in a dry year emergency.
Handy to have access when needed, but the reforms are in large part about not getting in a situation when you need this extra storage. But still, better to be prepared.

Ensure that the review of the Resource Management Act (second round) takes into account the needs of significant generation projects.
A la Project Hayes and central planning by the Environment Court …

Review options for providing clear government direction on the national significance of hydro generation in water allocation decisions.
In the South Island, in particular, there is deep seated, latent opposition to major hydro projects (like the ones built in the past) so this reform will be watched closely.

Improve the quality of published information on gas reserves and ensure that policies on petroleum exploration recognise the importance of gas for electricity generation.
It is currently difficult to get good information on gas reserves – it seems to change every time you look at it. Improvements in this area will be most welcome and will facilitate better planning around generation and better price discovery processes.

Review whether there are barriers to the development of geothermal energy.
OK, can’t be a bad idea even if not very specific. Sounds like something officials should be doing anyway doesn’t it?

Replace the Electricity Commission with an Electricity Authority (EA) as an Independent Crown Entity by 1 October 2010. The objective of the EA will be to promote competition, reliable supply and efficient operation of the electricity market for the long-term benefit of consumers. Set-up costs are to be met by a levy on the electricity industry as from 1 January 2010. Simplify the functions of the EA by transferring functions to other bodies: the System Operator to undertake emergency management and provision of information and forecasting on security of supply, subject to rules set by the EA; the Commerce Commission to undertake approval of grid expenditure plans by Transpower as part of its overall regulation of Transpower’s revenue requirements and expenditure under Part 4 of the Commerce Act; the Energy Efficiency and Conservation Authority (EECA) to take over the Electricity Commission’s energy efficiency programmes.
I won’t make any comment on the measures relating to EECA (as an EECA Board member) but the Electricity Commission has certainly had a lot on its plate. Many observers, including myself, have wondered about the amount of resource devoted to transmission vetting and approvals, possibly at the expense of other important work. Being more focussed may well improve the rate at which the market is improved in future.

The SO will not now be given responsibility for market operations (as recommended by the ETAG), and just as well because there was a clear conflict of interest with this proposal since the SO is itself a service provider to the market.

Set up a Security and Reliability Council, comprising senior level people from the electricity sector including electricity users, to meet periodically to help monitor and provide advice on the System Operator’s performance of its functions and on security of supply issues generally.
I detect a degree of dissatisfaction with Transpower’s performance viz a viz Otahuhu substation and other unexpected outages. But you do wonder what this new body will achieve unless it is resourced with people who understand the details of the reliability issues and are tasked to monitor Transpower to the degree required.

The Minister of Energy and Resources, in consultation with the Minister of Consumer Affairs, to have powers to recommend regulations on consumer fairness and equity issues.
Electricity does tend to be a political football, so are we saying “let’s make it easy for the politicians to play the game”?

The Minister for Consumer Affairs, in consultation with the Minister of Energy and Resources, to have powers to improve the electricity and gas consumer complaints schemes.
Mandatory participation by all electricity and gas retailers will ensure that minimum and uniform standards are met and that consumers will have real leverage when things go wrong.

Greg Sise, Managing Director