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Why electricity prices are rising

8 March, 2011

Does the market have a problem, or does the answer rest closer to whether we regulate for fairness, or something else altogether? Read Molly Melhuish’s blog for an answer.



7 March, 2011

DEUN is serious in its campaign against more electricity price rises. Read Molly Melhuish’s blog post.

Electricity Price and demand trends

7 March, 2011

Late last year Molly Melhuish provided Grey Power with a summary of the history of electricity demand trends and pricing, particularly since 1979. It provides a stark tale of ever increasing household electricity bills and unfair pricing compared to that paid by non-residential users, including Comalco.

Take a look for yourself at this brief analysis and trend graphs to support it.



Why electricity prices are rising

Why are electricity prices are rising? Not because the electricity market is wrong in itself, but because it is wrongly regulated.

The Electricity Industry Act has removed the objectives “fair” and “sustainable” from electricity regulation. It has reverted to the pure regulatory model of the Commerce Act. This is based on the economic model sometimes called “the Chicago School”, or “Reganomics” (or in New Zealand, “Rogernomics”). Here I will use the less pejorative term “orthodox”, a term used approvingly in some industry submissions on the Authority’s foundation documents.

Orthodox economic regulation is at the hard right-wing end of the economic spectrum. On the left-wing side, we have consumer-friendly regulation, which was typical of electricity regulation over the last half century especially in the United States. And in the middle, we have what I will call “balanced regulation”, designed to balance the needs of consumers with those of investors, to benefit both consumers and businesses to maximize benefit to the economy as a whole.

Orthodox regulation gives investors the right to use market power to maximize profits, subject only to “competition” however imperfect, as it always is in the electricity industry due to its peculiar characteristics.

Orthodox regulation allows and even encourages price-gouging of captive consumers. Excess profits can go anywhere - whether to increase directors’ fees, to invest in new power stations in New Zealand or overseas, or to return profits as increased dividends to their shareholders.

Consumer-friendly regulation controls profiteering, generally through price cap regulation, but tends to give incentives to price right up to the price cap. This encourages flabby, unambitious electricity supply businesses, or gold-plating of supply assets, leading to electricity surpluses, and in turn, cheap electricity for industrial consumers.

DEUN proposes to build and stand on the middle ground, of balanced regulation. This was attempted in the 2001 Electricity Act, where “fair” and “sustainable” were incorporated, into the legislation following a multi-year exercise by the Officials Committee on Energy Policy. However the electricity market was still governed through pure industry self-regulation on the orthodox model.

Consumers rejected self-governance of the market. This led to formation of the Electricity Commission, incorporating the objectives of the 2001 Act. But all its consultation documents were written in orthodox language, and submissions based on other models were simply rejected however much merit they may have had from “center or left-wing” perspectives. The Commissioner’s Board had consumer-friendly members, but their influence was small. After holding strong to his view that transmission investment into Auckland should be staged, the Commission’s Chair, Roy Hemmingway, was replaced by David Caygill, who fully accepted the priority being given to supply-side investment.

The 2001 legislation was still inconsistent with the actual decisions of the Commission, and was replaced in 2010 by a purely orthodox regulatory model.

As noted above, electricity regulation now fully condones exercise of market power constrained only by whatever competition can be created in the oligopolistic electricity industry. All generator-retailers (gentailers) have similar incentives, and each can exercise market power at whatever times that market conditions favour them – whether from low hydro flows or generator outages (which are allowed as a means of hiking spot prices), or other more arcane factors.

This orthodox model requires people harmed by high electricity prices to go somewhere else for relief – basically to the welfare system. It requires sustainability to be argued if possible through the Resource Management Act, plus the fiscal instrument of the emissions trading scheme. These remedies are so far removed from the electricity regulation that allows monopoly profits. Consumers and environmental/ sustainable energy advocates therefore remain unprotected from profit-maximising electricity suppliers.

EnergyLink, a company that advises on electricity markets, said at a seminar on 7 March that measures provided for in the 2010 Act will add risks which will be fully priced into consumer electricity prices. The impact will be similar to that of carbon pricing, and likely to increase significantly with “scarcity pricing”.


Campaign: No more electricity price rises

Electricity regulation allows price-gouging limited only by what Ministers tolerate, while the new Electricity Industry Act makes the market – not Government – provide for security of supply. This is giving companies the excuse for even further price hikes.

This “Fair Electricity” website was begun by DEUN to promote fair electricity pricing based on costs, not profiteering. DEUN’s manifesto calls for policies that make energy for all householders affordable and sustainable. This has become urgent with the new legislation.

Since the change in Government, government policies, echoed by companies' actions, have moved progressively to favor investors at the expense of consumers.

This timeline shows that Government has condoned price rises, and industry has responded by finding different ways to ratchet up wholesale prices, and the Electricity Commission (now replaced by the Electricity Authority), says these price hikes are necessary to ensure new power stations are built.

DEUN has participated in working groups throughout this period. We have openly deplored the lack of quantitative analysis to say HOW much prices would have to rise, and how much new generation could be deferred if only there were more investment in energy efficiency.

Other consumer groups have joined us in this call for better analysis. But to date the Authority has dug its toes in and is forging ahead on a Scarcity Pricing project which has almost unlimited potential for hiking prices to domestic consumers to build new power stations to hike the companies' asset values.

It is this relentless trend of government policy, followed by industry action, which convinces us that domestic power prices will continue to rise, unless regulation is changed to protect consumers instead of investors' shareholder value.


See 'Timeline: government progressively condoning ever-increasing power prices.'

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Electricity price and demand trends

This graph shows prices of electricity, in real 2010 c/kWh, from 1979 to 2010. Prices paid by average domestic consumers are shown in black; the weighted average of prices to industrial and consumers are shown in red.

The dotted lines show the trend in electricity demand, in gigawatt hours per year, over the same time period.

The prices followed each other fairly closely until about 1991, when market pricing began. “Electricity is like baked beans, no different from any other commodity” was the rationale given at the time for letting the market determine prices.

The large industrial and commercial consumers were able to negotiate quantity discounts for their electricity. Domestic consumers were treated as captive consumers, with all five retailer-generators (now called gentailers) raising their prices, the only constraints being public and media comment.

Demand trends reflected the price trends. The industrial and commercial sectors used nearly the same amount of electricity – about 10,000 GWh per year each - in 1984. Thereafter, the domestic demand grew only at the rate of population growth, while energy-intensive industry, commercial buildings, retail, and more recently irrigation, pushed non-domestic demand up.

Trends, shorter term

Market pricing became more firmly established after the restructuring of 1999, when local power companies were required to sell off either their retail and generation businesses or their lines businesses. Almost all kept their monopoly lines businesses, and sold off the more risky retail and generation businesses, which were bought up by the generating companies formed by the split of Electricity Corporation of NZ (ECNZ).

From 2000 till 2009, residential prices grew over twice as fast as the non-residential sector

Non-residential demand grew just over twice as fast as residential demand, with a fall-off in 2009 due to the recession.

Comalco's demand dropped suddenly in late 2008, with a transformer failure.

Over the first half of this period, non-residential demand was growing three times as fast as residential; the growth rate has moderated since.

The electricity industry, supported by Government statements, says domestic power prices must continue to rise, to ensure new power stations can be built to meet growing demand. But commercial and industrial demand is rising faster than domestic demand: this is unfair.

Note, “residential” and “domestic” in these data sets mean exactly the same thing. The data sources is the Energy Data File 2010 edition, published by Ministry of Economic Development.

Price trends, longer term

The long-term trends of electricity price are particularly interesting to Grey Power members, who well recall the period in the mid 50s through early 70s, when residential prices were lower than commercial and industrial prices.

Government policy had been that everyone would pay the same for electricity. Since commercial and industrial consumer could claim electricity as a tax-deductible cost, their prices were set approximately 30% higher than prices for domestic consumers.

The downwards trend in all electricity prices in the first half of this graph resulted from economies of scale, with the Waikato and Waitaki schemes being developed. Development of Kapuni and Maui gas from about 1971 through 2002 kept prices relatively low.

Shortage of Maui gas in 2002 led to almost tripling of the wholesale gas price, a major factor in the increase of all prices thereafter.

The electricity industry, supported by Government statements, says domestic power prices must continue to rise, to ensure new power stations can be built to meet growing demand. But commercial and industrial demand is rising faster than domestic demand: this is unfair.


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