Energising New Zealand. Policy Document

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1 Energising New Zealand Policy Document

2 Executive Summary 1. The Problem Prices for households have been increasing at double the rate of inflation. Prices are rising faster than most of our major competitor countries. The gulf between industrial and residential prices in New Zealand is the second highest in the OECD. 2. Why Prices Rise so Fast First, there is a lack of competition in the electricity market. The Wolak report found the four big generators made super profits of $4.3 billion at the expense of consumers. Other evidence is listed in the document. Second, the pricing system isn t fair to consumers. o New Zealand is a country rich in low-cost renewable power. But residential consumers see little benefit from that. o Hydroelectric power makes up almost two-thirds of our electricity, and costs next to nothing to generate because it uses free water and dams that were paid for years ago. o But when this electricity is sold on the market, the companies get paid the same amount as other generators using more expensive methods, like gas. o That means in most cases electricity is selling for much more than it costs the company to generate. o Generators end up earning super-profits using free water to justify ever higher valuations. 3. Key Points of Labour s Solution A new agency called NZ Power will act as a single buyer of wholesale electricity. It will also have the power to set prices based on operating costs and a fair return on capital. NZ Power will introduce a new pricing system where electricity companies get a fair return and consumers finally get a fair go. These measures will also encourage more competition among retailers. 4. Impact of Policy Power prices for the average household will drop by $230 - $330 a year. Businesses will also see prices lower by between 5 and 7 per cent on average. This policy will create 5,000 jobs and boost the economy by $450 million per annum. Page 2 Energising New Zealand

3 Section 1: The Problem The relentless rise in electricity prices has to be brought under control. It s time to call a halt to National s so-called Bradford reforms. This hands-off leave it to the market approach has failed. Electricity prices for households have been increasing at double the rate of inflation. 1 National s plan to sell our assets will push up power prices even more as foreign and corporate investors look to maximise profits. 1 MED, Annual Electricity Prices (Real) Page 3 Energising New Zealand

4 Prices are rising faster than in many of our major competitor countries. 2 This is unfair to consumers and undermines the competitiveness of our economy. 2 International Energy Agency, Energy Prices and Taxes online database, 2012 Page 4 Energising New Zealand

5 An enormous gulf has also grown between industrial and residential prices. According to the International Energy Agency, the difference in New Zealand is now the second highest in the OECD. 3 NZ households pay almost three times more than industrial users per unit of electricity. Residential prices are too high. 3 International Energy Agency, Electricity Information (2012 Edition). Part. III.55. & International Energy Agency, Electricity Information (2012 Edition). Part Page 5 Energising New Zealand

6 Section 2: Why Prices are Rising so Fast The Price System isn t fair to Consumers New Zealand is a country rich in low-cost renewable electricity production, mainly through hydro-electric power. It s one of our big competitive advantages. But we re not making the most of it. The way our electricity market works means prices paid by households and most businesses are not related to production costs. Instead, all generators are paid the same price, whether they are using the public water resource or expensive gas. That s because there is a fundamental flaw in the way electricity is priced. Electricity in New Zealand is currently traded at a wholesale level in a spot market where every half an hour the price is set by the generator who supplies the most expensive electricity. That price is then paid to every generator who supplies electricity during that period, no matter how low their actual costs of production are. In particular owners of hydro-electric generation are taking the nation s free water resource and turning it into super profits. This is a multi-billion dollar transfer of wealth to generators paid for by consumers. That s simply not fair. Hydroelectric power makes up almost two-thirds of our electricity, and it costs next to nothing to generate because it uses free water and dams that were purchased years ago. As you can see in the graph below. But when this electricity is sold on the market, the companies get paid the same amount as other generators using more expensive methods, like gas. That means in most cases electricity is selling for much more than it costs the company to generate. Generators end up earning super-profits using free water to justify ever higher valuations. The current system leads to generators revaluing their businesses substantially ahead of inflation almost every year. The value they ascribe to their assets is inflated because they are taking into account the increasing cost of new generation. This system keeps driving up prices. Under the current model, prices are still heading higher despite current flat demand. Earlier this month, the CEO of Contact Energy said in order to build new power stations over time you will have to increase those wholesale prices." /04/2013 More power price hikes tipped Business Day Page 6 Energising New Zealand

7 Source: MED, Energy Data File 2012, p 108 and Meridian Energy, Options, Choices, Decisions, 2006, p 13 There is a lack of competition in the electricity market Achieving a competitive electricity market is always difficult in any country. This is because electricity cannot be stored, and relies upon a complex system of generators, grid, local lines and retailers. The sector has high barriers to new entrants, and it is in the interests of incumbents to exclude them. Achieving real competition in New Zealand is even harder because of our small market, our long stringy geography, and our inability to import electricity from neighbouring countries. Our large proportion of hydroelectricity which comes from using the public water resource provides a huge source of low cost generation, but also causes complications not found in systems based on coal or gas generation. However, there is considerable evidence that the electricity market is not competitive, especially in the market for residential customers. When markets are not truly competitive, consumers bear the cost. Uncompetitive markets misallocate resources within the economy and consumers bear the cost. The evidence includes: A 2009 report by international expert Frank Wolak which concluded that between 2001 and 2007, the four big generators extracted super profits of 18 per cent ($4.3 billion) which came at the expense of higher prices for consumers. The inexplicable divergence of industrial and residential tariffs. This difference cannot explained away by transmission costs, and according to Page 7 Energising New Zealand

8 the International Energy Agency, the difference is the second most extreme in the OECD. The fact that the rate of residential price increase is much higher compared with other countries despite the abundance of low-cost renewables in New Zealand. Household Electricity Prices (NZ Cents per KW/h) Today Canada * New Zealand United Kingdom United States *Latest IEA figures available for Canada are Consumers in centres close to generation sometimes facing pay higher prices than those more distant, despite lower lines losses meaning their power should be cheaper. The concentration of retailers in companies owned by major generators. Promoters of the current approach to the electricity sector have always hoped that a vibrant, dynamic market would develop with many buyers and many sellers. This has not occurred. The use of carbon pricing as a reason to increase electricity prices, but no corresponding decrease when carbon prices collapse to close to zero. The less efficient use of resources from National s widely criticised forced transfer of some of the hydro stations from Meridian to Genesis. The fact that despite very tight generation and transmission margins in the 2000s, government intervention was required to bring forward sufficient investment. Interventions included underwriting gas supplies for E3P, and modifying the government policy statement for the Electricity Authority to encourage approvals for grid upgrades. A lack of restraint and corporate excesses. In particular by the big electricity companies reflected in million dollar salaries and rising director s fees. The failure of the Bradford reforms which predicted price would go down, instead they increased. Max Bradford himself said in 1998 that I am perfectly confident that we will see some quite significant reductions. 6 5 MED, InternationalComparisons Household Electricity Prices 6 21 Apr 1999 Apology to Bradford for electricity-price gaffe NZ Herald Page 8 Energising New Zealand

9 Section 3: Labour s solution Labour will be hands-on to reduce power prices and moderate future increases. Below is a detailed analysis of key parts of the policy. We will establish NZ Power a new independent Crown entity to have a central role in the planning and operation of the electricity system, taking a holistic approach. Current Approach No one plans the New Zealand energy sector and ensures it operates for the benefit of all New Zealanders. There are multiple regulators (Electricity Authority, the Commerce Commission and the Ministry of Business, Innovation and Employment) and multiple industry participants, making important decisions in isolation. Some investment decisions (Transpower) are closely monitored, while others (generators) are left completely to the market. How scarce national resources like water are used is decided by private parties. Labour s Approach NZ Power will have the ultimate government responsibility for energy sector planning. It will be required to determine future investment needs for generation and seek competitive proposals for the construction of new plant and equipment. While it will not own generation plants or guarantee their profitability (that commercial risk will rest with the generators), it will ensure New Zealand has the right amount and right type of generation capacity into the future. NZ Power will take over the existing functions of the Electricity Authority; the economic regulation of electricity markets from the Commerce Commission, together with the regulatory powers of the Secretary of the Ministry of Business, Innovation and Employment (MoBIE) under the Electricity Act We would expect in time to see NZ Power take on most of the functions that the Electricity Authority has out-sourced. We will investigate whether to merge the electricity system operator function from Transpower with NZ Power. NZ Power will act as a single buyer of wholesale electricity. It will have the power to set prices. NZ Power s goal will be to sell electricity at lower, fairer and more predictable prices. It will use its planning and buying roles to ensure that the overall energy system is configured to deliver this goal. This puts consumers at the heart of the energy system; they will no longer be the powerless recipients of whatever the uncompetitive market decides to deliver. The current pricing model will be dumped. NZ Power will act as a single buyer of wholesale electricity. Each generator will be paid a fair return for their actual costs. The fair return will be calculated by NZ Power on the basis of their historic Page 9 Energising New Zealand

10 capital costs, possibly adjusted by inflation, plus operating costs like fuel, depreciation and maintenance. Many states in the United States use similar models, including pricing models based on historic cost, plus fuel. Examples include California and Virginia. Other examples include South Africa and Brazil. Brazil in particular has brought forward a lot of new generation to meet rapidly growing demand as their economy grows and also faces policy challenges of hydro compared with thermal generation like New Zealand. There will be a cost based price pool for wholesale electricity, with generators still offering bids of available electricity supply and the single buyer dispatching the lowest cost bids. The price will still vary regionally reflecting transmission costs and line losses as at present. NZ Power or Transpower will make decisions on what generation should be dispatched at any point in time based not just on the submitted bids by generators, but will seek to optimise short and medium-term issues like fuel supplies. It will have the ability to direct that available capacity be used, even if it has not been bid, thus avoiding the ability of generators to use market power to maximise short-term profits by withholding low-cost generation. NZ Power will sell electricity to retailers on the basis of long-term contracts. Large individual industrial users could contract directly with NZ Power. The contracts will be sufficiently flexible to ensure that the consequences of hydro supply constraints in dry years will still be able to be reflected in the contract price. NZ Power will be expected to cover all of its costs including on its electricity trading operations, on average, over the long term. NZ Power will plan for new generation and invite offers to build new plants. New generation can be purchased via long term contract negotiated by the single buyer through competitive tender. The cost of that new generation will be averaged into the retail market. This approach is common-place overseas. The 2011 World Bank report Electricity Auctions: an overview of efficient practices details many examples. 7 NZ Power will be able to encourage energy efficiency programmes. One of the advantages of single buyer procurement is that energy efficient alternatives (or move demand to avoid the need for more expensive peak supply) can be considered alongside new generation alternatives, for example, insulation and photovoltaic. Currently generators, lines companies and retailers are all rewarded for selling or carrying more electricity. Cost effective efficiency alternatives are not adequately considered, which increases long term costs. 7 d+side+auctions.pdf?mod=ajperes Page 10 Energising New Zealand

11 In addition the operation of a cost based price pool enables the use of smart grids which allow New Zealanders to make real-time decisions about the best way to use energy should they so choose. Retail competition will be encouraged. Generators and retailers will be structurally separated Because NZ Power will be the sole buyer of wholesale electricity, generators will not need to vertically integrate to control risk. NZ Power will thus require the owners of the existing major electricity companies to separate their retail arms into separate, standalone companies with separate boards and management. We will not initially require divestment, but NZ Power will be charged with monitoring the development of the retail part of the sector to determine whether this is required in the interests of consumers. This will lower barriers for new companies to entry. In particular it will allow lines companies and others to compete more effectively in the retail market. The regulation of lines companies will also be simplified. Page 11 Energising New Zealand

12 Section 4: Impact of Policy Labour will lower power prices We expect the average household will save between 10 and14 per cent or $230 and $330 a year (based on 8,000KW hours of electricity). Businesses will also save between 5 and 7 per cent. We expect total electricity charges will be reduced by between $500 million to $700 million a year. NZ Power will contract with retailers to ensure that around two-thirds of that reduction will flow to residential consumers, with the other third going to commercial and industrial users. These savings come as a result of NZ Power setting a price based on operating costs plus a fair return for capital based on the historic cost of their assets with some adjustment for inflation. This will flow through into a downward valuation of power assets. Since the late 1990s, electricity companies have revalued their assets upwards by almost $12 billion. Lower power prices for consumers mean some of those revaluations will be wound back. Over time this will have an effect on the share value of the generators. The exact effect will depend on the price set by the single buyer and the market s view of an appropriate rate of return for generators. This policy will also create jobs and boost the economy It will reduce cost of living pressures on New Zealanders and also help stabilise future electricity prices. Independent advice from economists BERL found reductions in electricity prices of this magnitude will create over 5,000 jobs and boost economic growth by $450 million. Lower power prices will mean that people will have more money to spend and that stimulates our economy. Lower power prices for industrial and commercial users will improve their competitiveness and allow them to invest in expanding their business. It s also good for economic development Labour's energy sector reforms will boost economic development. We currently have a predominantly clean source of energy production. However, what we lack is an energy supply that has a fair price. Far too many gains are being pocketed by energy generators and retailers at the expense of consumers. The introduction of a single buyer model will reduce energy costs for business owners and future investors in our productive sector. For example, New Zealand has an enormous forest resource which is disproportionately disappearing overseas in a raw, unprocessed form. It is essential we improve the returns from the "wall of wood" growing in front of us. The provision of affordable energy that encourages investment in enterprises that add value to our raw timber resource is positive and overdue. We have heard too many stories about how the current Page 12 Energising New Zealand

13 energy trading system does not deliver outcomes conducive to further enterprise development. Investors do take account of energy costs and availability when developing investment proposals. It is about time that politicians showed the boldness and leadership needed to promote and simplify investment pathways. We have the ability with our significantly low cost energy sources to facilitate and enable the growth of further secondary and tertiary processing in New Zealand. It is totally unreasonable that such initiatives should be hobbled by an energy system which gouges the consumer base and spreads the fiction that power is not over-priced. As an important part of this reform process, Labour will be engaging with key industry sectors. This will ensure that the changes serve the purposes of job creation, further investment and future improvements in the value added strategy, vital to the fortunes of the NZ Inc. Page 13 Energising New Zealand

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