Don’t blame the market for hikes

Posted 1 September 2014 by Chris Hargreaves

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Electricity price rises are coming from the regulated parts of the industry, writes Chris Hargreaves in the Sunday Star Times 31 August 2014.

Rod Oram’s recent comments in the Sunday Star Times and on National Radio were critical of the current market prices for retail energy and the way in which increased profits were distributed to shareholders by generators and retailers – rather than being used to bring retail pricing down.

While Rod’s comments bear thinking about, his analysis failed to take into account market changes over the past few years – and the considerable impact of key pricing factors such as transmission and distribution charges (both of which are regulated and out of the control of retail providers).

Rod Oram also appears unaware of the significant reductions in energy prices that have benefitted commercial users of electricity in the past. Total Utilities Management Group has seen reductions averaging 20% on recent contracts since the last quarter of 2012 as both generators and retailers have rebalanced their regional and commercial portfolios in response to changes in generation capacity, lower demand and increased regional competition.

Electricity pricing in New Zealand is far from transparent. This leads to uncertainty around how invoiced prices are derived and means that changes to the various cost elements can be difficult to police. This uncertainty can muddy the water when talking about the historical cost of contestable energy prices.

The Electricity Authority recently released a Statistics New Zealand survey covering historical retail residential pricing with figures backed up by the MBIE.

https://www.ea.govt.nz/about-us/media-and-publications/i-on-the-market/2014/18-retail-prices

STT graph

 

 

The graph above clearly shows where the underlying drivers for cost increases are coming from. Only the blue areas are contestable – this is where customers have choice between retailers and where the competitive market operates. The contestable energy portion of a typical monthly invoice accounts to around 65% of the total cost. Around 90% of all cost increases seen over the last three years are due to changes in non-contestable transmission and distribution costs.

According to the study, over the last 12 months the cost of the energy (competitive) portion of electricity increased by an average of 0.3% nationally, over the last three years energy increased by an average of 0.5%. The previous seven years prior to 2011 saw increases of 7.1% – much of this was due to regulated competitive constraints in the market and capital infrastructure projects.

During Rod Oram’s interview on Radio New Zealand (link to audio) after the Contact Energy and Meridian Energy profit announcements, the line between contestable charges and regulated ‘pass-through’ charges was blurred when historical cost increases were discussed.

However, some facts do remain:

  1. Demand is flat but starting to increase slightly
  2. Low demand means there is little incentives for building new generation assets

Rod asked, ‘If the above is all true, why are Generator/Retailers not reducing prices when underlying wholesale costs are low.’ To turn this logic around, would residential customers accept much higher prices when the wholesale market spiked?

Generator/Retailers are now indexing their retail pricing to the ASX futures market – which combines a number of longer-term factors to smooth out short term fluctuations. This system has been in place since 2009 and has had a powerful stabilising influence on fundamental market pricing.

SST image Total Utilities

The graph above illustrates the volatility of the wholesale market. This is something that residential and small business customers are not exposed to – retailers typically update their energy prices once every 12 months or so. The average Spot price since January 2012 has been $74.51/MW (7.451c/kWh).

Wholesale Spot pricing is derived from a number of variables that include but are not limited to available hydro lake level storage (at maximum volume NZ has only 6 weeks supply), immediate and short term climate outlook, scheduled and unscheduled maintenance of base-load generation assets and the cost of fossil fuels (around 20-25% of total generation).

Despite this, Rod Oram appears to be complaining that limiting retail cost increases to well below CPI or inflation is not enough and that the average cost of retail energy should be dropping considerably if the market were truly transparent and competitive.

There are plenty of reasons for the cost increases post-deregulation which I will cover in my next blog, however what we see now is a huge increase in market participants giving customers a huge number of retailer options and choices. In the commercial energy space we continue to see large reductions in fixed energy prices, better contract terms and conditions and more creative products for customers.

Fundamentally, all of the arguments currently in the media are driven by residential prices. They forget or fail to understand that residential rates under ECNZ were subsidised by industrial customers. Deregulation has changed this somewhat.

Residential customers have a much greater cost to service than larger commercial customers and some of the cost increases seen since 2000 have resulted from the removal of artificial subsidies. It is critical to note that residential consumers are still not covering their cost to serve at current pricing levels.

Rod also appears to be a fan of the Labour/Green power policy which has been condemned by nearly everyone in the business community – and by studies completed by the Electricity Authority and Business New Zealand. (links) The fundamentals of the NZ Power policy have been derived from a study conducted by Professor Frank Wolak of Stanford University prior to industry changes made by National in 2009. Since the announcement of NZ Power, Professor Wolak has described the policy as a ‘sham’ and that ‘a single buyer model could be a disaster.’

Total Utilities and Professor Wolak are in favour of more competitive reform in energy generation and retail with greater controls over regulated monopolies. Our next blog will cover the historical context and current competition constraints.

 

Find out more about how Total Utlities can help you with your electricity procurement and tender process.

 

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