Why Competition?
In the late 1980s and early 1990s, several countries began to restructure their electricity industries, on grounds that traditional electricity monopolies were unnecessarily inefficient.
Traditionally, electricity industries around the world were characterized by “vertical integration”: in each country or geographic region, the generation, transmission, distribution and retail segments were typically bound together, operating under direct government ownership or as a regulated monopoly. In the late 1980s and early 1990s, several countries began to restructure their electricity industries, on the advice of economists, policymakers and electricity consumers who argued that the electricity monopolies were unnecessarily inefficient. These advocates pointed to earlier successes with competition in segments of telecommunications and transport. A basic model for electricity restructuring emerged first in the UK, followed by some US regions, New Zealand, Australia and (more gradually) other parts of Europe: split up the vertically integrated electricity organizations and introduce competitive markets in generation and retail, while continuing to regulate the “natural monopoly” transmission and distribution segments.
Of course, competition and unbundling are not ends in themselves. The aspiration of restructuring is to stimulate efficiency – in production, delivery and consumption – and put downward pressure on prices. The idea is to achieve this through three broad mechanisms. First, and most importantly, competition in the generation and retail segments is supposed to provide incentive for profit-seeking firms to improve efficiency in the short-term (through better use of existing plants and inputs such as fuel and labour) and in the longer term (optimised quantity of generation capacity, better choice of technology, fuel source, and plant location). Second, giving consumers greater exposure to market prices for electricity should improve the allocation of electricity consumption and cut down on waste. Third, economists have pointed toward the potential for productivity gains from introducing “incentive regulation” to improve the performance of firms that own and operate the transmission and distribution networks.
This Policy Perspectives focuses primarily on the first of these three broad mechanisms, particularly competition between generators, although we will see that getting this right often depends on getting the other two mechanisms right as well. This paper provides an overview of the international experience with generator competition and draws ‘lessons learned’ that may be useful in the New Zealand context.
Government has to take responsibility for institutions and regulations to support a competitive electricity marketplace.
As Hogan (2003, p. 3) puts it, “successful electricity markets require new institutional infrastructure with a visible hand to support competition…The market cannot solve the problem of market design.” In other words, government needs to set up and maintain the right institutions and regulations to support a competitive electricity marketplace.
