Gareth Morgan explains why you should be worried about the Labour/Greens electricity proposal

By Gareth Morgan*

The Labour Greens proposal (NZ Power) has sparked a long overdue debate about electricity prices.

Despite what National claims the NZ Power model is perfectly workable, and indeed similar models are in place overseas.

The real question is whether the idea is a sledgehammer to crack a walnut? We think so.

The NZ Power proposal is classic politicking; a solution in search of a problem.

Labour and the Greens have thrown up a grab bag of different reasons for it including fuel poverty, power companies using free water, price gouging and asset sales.

Let’s take a look to see how the arguments stack up.

Fuel vs Poverty

Fuel poverty certainly exists, along with food poverty, health poverty and housing poverty. But really isn’t it all just poverty?

And like all those problems the solutions to poverty are better found in our tax and welfare system than in tinkering with our electricity market.

There is little reason to think that the benefits from the Labour/ Greens proposal would go to the people that actually need it.

Private Hydro Companies Use Public Water

It is true that hydro power generators get paid a lot more for the power they generate than it costs them to make the power. This is because hydro is so cheap to run compared to all other forms of generation. In the old days Electricorp and its predecessors only charged for power based on the average cost of generating the electricity. This meant that we all got the benefits of cheap hydro power.

Nowadays we use marginal cost pricing, which means we pay for all electricity based on the cost of the most expensive source of power used. While this has meant prices have risen, the system actually makes sense because it gives the right incentives both for power generators to build new power stations if there is too much demand, and for consumers to conserve power. The result is that we as a society, use the optimal amount of power.

Labour and the Greens now think it is unfair that the private power companies can use dams our nation built and water that (supposedly) nobody owns to generate power at a huge profit.

Let’s be clear though – shareholders bought those companies at the going rate and so the Government has already reaped the benefit from these profits – the sale price the Government got was far higher than it cost to build the dams in the first place. It was based on charging the marginal cost of electricity in future.

If it is now deemed unfair that hydro generators can use water for free, then charging generators for water use would be a better remedy than tinkering with the electricity market.

In fact this is exactly what we have previously suggested also needs to happen to other commercial water users, such as farmers.

Such a charge would not affect power prices (because hydro is so much cheaper than the alternative generation which underpins the market price these days) and the revenue could be used to improve our rivers, shared amongst taxpayers, or as a rebate to electricity users (if power prices are seen as the problem).

Price Gouging

There have also been various claims of price gouging in the electricity sector. With five large power generators, manipulation is certainly possible. However, as yet there is no evidence of price gouging – wholesale prices have recently been pretty stable.

If anything, the competition problem probably lies in the electricity retail side. This could be solved by a lighter touch approach – ensuring that there is a decent hedging market in place. A hedge market would allow anyone to get long term certainty about electricity prices – whether buying or selling it. This would mean that independent generators (including for example households or communities with wind turbines) and retailers could enter the market without fear of being stomped on by the big guys that have both generation and retail arms and might be able to manipulate the spot market.

Risks with NZ Power - Investments

At the moment the electricity market sends lots of signals to the generators and users of electricity to help them make their decisions. The NZ Power model would mean government takes over the responsibility (and risk) for getting these decisions right. Does a Labour/ Green government really want to bear that extra burden?

It can be done, but it isn’t easy.

Firstly they need to overcome the legal challenges that are likely to come from hydro generators as a result of writing down the value of their assets.

Then they need to dodge the inevitable industry calls for Government to bear the risk of supply disruption.

Then they need to set the prices, a role that the market does now.

Set them too low, and investment will dry up. Set them too high, and we will get an excess of power supply.

If this happens (or demand drops as it will when Tiwai closes) it becomes difficult to drop prices, as NZ Power will have guaranteed a return on assets, so prices end up higher than they need to be.

In most countries where this approach has been tried, conservative government officials tend to opt for too much power, just in case.

Risks with NZ Power – Environment

The Labour Greens proposal is also strange given their stance on the environment and Emissions Trading Scheme.

All power generation has an environmental impact (even wind), and if we drop power prices then people will probably use more. That means more power stations.

Contrast this with their plans for the Emissions Trading Scheme, which would increase electricity prices.

This would provide an incentive for electricity consumers to reduce their power use, so we have reduced need for new power plants (especially coal and gas ones).

It seems weird to have price controls aimed at reducing power prices and an ETS aimed to increase them.

What Could Be Done Instead?

However there is still hope.

The ‘lighter touch’ solution of a futures or hedging market set out above could be picked up by National as a middle ground. Or the Labour/ Greens proposal could be subtley reined in to similar effect.

Either way, lets hope that electricity doesn’t become another political football which flip flops with every new Government, like the top tax rate, ACC or superannuation.

In summary, here is our 3 point plan for the electricity sector:

1. Charge hydro generators for the water they use (this wouldn’t affect the price)
2. Regulate the hedge market, to improve competition (this should drop the price, especially on the retail site)
3. Hurry up and close Tiwai, which should drop electricity prices by 10%, plus save the Government any future bribes (such as the recent $30million payout to Rio Tinto)

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Gareth Morgan is a businessman, economist, investment manager, motor cycle adventurer, public commentator and philanthropist. This opinion piece was first published on his blog garethsworld.com and is reprinted here with permission.