Implications for New Zealand

The preceding discussion about the international literature on electricity market policy raises three questions regarding New Zealand.

Little empirical research exists regarding market power in the New Zealand context.

What evidence is available from empirical measures of market power in New Zealand? The short answer is that very little work has been done to apply the empirical measures described above to New Zealand. As a result, it is very difficult to assess whether or not market power is a problem for New Zealand’s wholesale market. Murray and Stevenson (2004) look at market shares of generating firms. According to their analysis, the top five firms (Meridian, Contact, Genesis and Mighty River) accounted for 86% of New Zealand generation capacity in 2003 (p. 14). Overall, they calculate a Herfindahl-Hirschman Index of 2031. According to Twomey et al (2004), markets with HHI above 1800 can be “broadly classified” as “highly concentrated” (p. 17). At any rate, as the preceding pages should have made clear, concentration indices alone mean little. A comprehensive assessment would consider several of the other measures discussed earlier. One other piece of research on market power in New Zealand (Videbeck 2004) argues that (for the 1997-2002 period) generators were unlikely to have exercised substantial regional market power because regional prices were highly correlated.

How does NZ do in terms of getting market design and institutions right to mitigate the scope for market power? The above discussion mentions several factors that should help mitigate the scope for market power. Several of these could be particularly important in the New Zealand context.

The transmission regulation experience of England and Wales holds lessons for New Zealand.

• Transmission capacity and transmission regulation: A full discussion of this complex subject is beyond the scope of this paper. However, one instructive exercise is to draw some broad comparisons between New Zealand and the regulatory regime in England and Wales, which is regarded as a benchmark in the imperfect world of transmission regulation.[19] At a broad level, both regimes share some characteristics. They both feature some form of incentive regulation: that is, a profit-seeking firm (Transpower in New Zealand and National Grid in England and Wales) is subject to incentive mechanisms to promote efficient network operation and investment. These incentives augment grid investment regulatory procedures in which regulators are responsible for monitoring and approving investment. However, there are some important differences between New Zealand and England and Wales. First, the England and Wales incentive regime is more comprehensive – in particular, there is an incentive mechanism that offers the transmission company financial bonuses and penalties to minimize congestion on the grid. Second, the transmission investment approval process is arguably less contentious in England and Wales, thus underpinning a more stable environment for generation investment (and electricity consuming industrial projects).
• Demand side responsiveness: New Zealand’s wholesale market, like others around the world, has highly inelastic short-run demand, even though some large electricity consumers have meters that allow them to see and respond to hourly price changes. As in other countries, boosting elasticity of demand is partly a matter of waiting for technological improvements, such as less expensive consumer meters. The Treasury’s (2005) report on electricity “demand-side management” discusses various options including “smart meters” and existing “ripple control” technology (which could allow widespread contracting for shut-off of hot-water heating during periods of high wholesale market prices).
• Market monitoring: The Electricity Commission (EC) was created in 2003 and is charged “to ensure that electricity is produced and delivered to all classes of consumers in an efficient, fair, reliable and environmentally sustainable manner.”[20] The preceding discussion of market monitors suggests a few comments regarding the EC. First, the EC could usefully build on efforts to examine various empirical measures and publish them regularly along with analytical discussion. Second, the overlap in mission with the Commerce Commission need not be a problem. The Commerce Commission is charged with investigating “anti-competitive” practices under the Commerce Act of 1986. But these investigations are necessarily backward looking with a focus on evidence that will survive legal tests of criminal wrongdoing; as we have seen, detecting market power is an inexact science. The EC should focus on a prospective approach to mitigating the scope for market power. Third, independence from political decision-makers helps bolster a consistent, impartial approach to market monitoring.

Do New Zealand wholesale electricity prices give adequate incentive for long-term investment in generation? There are two reasons to be concerned about the incentives for investment in New Zealand. First, the Government’s Whirinaki generation capacity agreement may act as a “soft” price cap.[21] In 2005, the plant was operated for only 69 hours for reasons other than testing (International Energy Agency 2006). However, as discussed earlier, investment incentives are sensitive to the prices obtained in rare “high demand” hours. Without careful empirical analysis, it is difficult to know whether the Whirinaki scheme causes a “missing money” problem and dampens investment incentives, although this should be a concern. Second, policymakers in New Zealand should be aware of the concerns outlined in the preceding section: the wholesale market may not work well during crucial high-demand hours and thus prices may not be provide optimal signals for investment. It is worth examining the possibilities for a “resource adequacy program”, possibly including capacity markets, to address any “missing money” problem (see Cramton and Stoft 2006 and Joskow 2006). However, as noted above, it is crucial to make sure this is designed carefully – drawing on the existing international evidence – in order to avoid introducing new distortions. Policymakers should strenuously avoid simply throwing money at new generation. Indeed, this leads to the third, and perhaps most important, concern about incentives for investment in New Zealand: investors may be leery about committing money to generation in an environment where policy and regulatory changes may allow the Government to effectively “hold up” generators and appropriate scarcity rents at some point during the life of a prospective plant. In other words, even if wholesale prices were sending efficient signals for optimal investment today, investors might justifiably balk at the prospect that regulatory changes might change the picture after a few years.