Comment on issues raised by Committee members on 21 April 2010

Transcription

1 Electricity Industry Bill Comment on issues raised by Committee members on 21 April This note provides further comment on a number of issues raised by Committee members on Wednesday 21 April. 2. The note also attaches a track-change version of the officials report on submissions in response to comments by Committee members. Electricity prices: Wolak report 3. A question was raised as to whether the section on electricity prices in the officials should refer to the Wolak report. The Wolak report identified the exercise of market power in the wholesale market as causing high wholesale electricity prices, leading in turn to high retail prices. 4. Although the Ministerial Review agreed with the Wolak report that there was scope for stronger competition in the wholesale market, it did not consider that the exercise of market power in the wholesale market was the primary cause of the increases in electricity prices to residential consumers. The Review noted that a number of significant flaws had been identified in the Wolak report 1 and it concluded that, using a benchmark of LRMC (long-run marginal cost), there was no clear evidence of the sustained or long term exercise of market power in the wholesale market A summary of the reservations the Review had about the Wolak report, and further background material, was provided to the Committee in February. 6. In contrast to the Wolak report, the Ministerial Review identified inadequate competition in the retail market as the primary cause of rising and apparently excessive retail margins for residential consumers. This is indicated in the graph included in MED s initial briefing to the Committee and reproduced below. 1 The Ministerial Review identified a number of serious reservations about the report, including: o Underestimation of the opportunity cost of hydro, that is, the value of water preserved for later use. This is crucial, since it is efficient for spot prices to rise to reflect the increasing risk or probability of water shortages, given the very serious and prolonged economic and social consequences of actually running out of water o o o Underestimation of the opportunity cost of gas, and overestimating its availability, particularly in the light of the decline of the Maui gas field SRMC price levels (which Wolak uses as the competitive benchmark price: see next footnote) are not sufficient to cover the costs of building new capacity and ensuring security of supply The analysis was done in hindsight, and assumes perfect foresight on the part of decisionmakers, with no apparent allowance for the uncertainties that parties face in the real world, such as future demand, plant reliability and hydro inflows. 2 The Wolak report used a benchmark of system SRMC (short-run marginal costs) which exclude capital costs for the marginal station. In the Wolak report, spot market prices above system SRMC were regarded as demonstrating, and used to calculate the extent of, the exercise of market power

2 Average cost (in real terms) excluding network charges Real 2008 cents/kwh Est. cost of new supply Commercial average Residential average Industrial average Wholesale market prices have tracked quite closely to the estimated cost of new supply (the yellow squares), which underpinned the conclusion of the Ministerial Review that there was not a major issue with the exercise of market power in the wholesale market. 8. In contrast, retail margins have clearly increased significantly for residential consumers. They also appear to be substantially higher than margins in other comparable jurisdictions (eg eastern Australian states and the UK). Accordingly, the Ministerial Review identified inadequate competition in the retail market as the primary issue which needs addressing with regard to prices, and made recommendations designed to increase the level of retail competition. 9. Thus, the officials report does not focus on the Wolak report because the Ministerial Review had a different view as to problem identification. 10. Just incidentally, as a point of interest, the Wolak report s primary recommendation to address market power in the wholesale market was to break-up generation assets (including through substantial asset swaps). It concluded this was necessary to improve the balance between generators in terms of geographic location and generation-type and thereby the level of competition in the wholesale market. Cost-benefit analysis on the transfer of Tekapo A and B to Genesis 11. Some Committee members considered that insufficient information had been provided in the official s report on the costs and benefits of the proposed transfer of Tekapo A and B to Genesis. They requested that officials provide further cost-benefit information. 12. A brief indicative cost-benefit analysis is attached as Appendix A. As noted in discussions with the Committee, the benefits depend materially on assumptions about the impact of additional competition on the behaviour of market participants

3 13. The indicative CBA provides the following bottom line figures ($m NPV) for the proposed transfer: Mid-point Range Excluding contingency for loss of water use efficiency Including contingency for loss of water use efficiency 20 (13) It is important to note the following points: The numbers are not large. In part this is because the assets involved are not large. Tekapo A and B represent about 2 % of New Zealand s generating capacity (MW), about 1.5 % of generation (GWh) in a dry year and about 2.3 % in a median inflow year. As noted in the Committee discussions, the proposed asset transfer is a small one. More importantly, these figures do not include reductions in prices to consumers resulting from lower retail margins (except insofar as these reductions are the result of efficiency gains). A large part of the benefit to consumers from increased competition is pressure on profit margins: however such reductions are not counted in cost-benefit analysis because they are transfers (consumers are better off, but producers are worse off, leaving no change in the overall size of the economy). Thus consumer benefits are likely to be higher, and potentially significantly higher, than economic benefits (which are the focus of cost-benefit analysis). Treasury comment on the ETAG report 15. The Committee s attention was drawn to the following statement in a report from Treasury to its Ministers: Following submissions the TAG decided not to recommend any of the physical asset swap proposals, favouring virtual asset swaps instead. Subsequently the Minister of Energy decided to recommend a combination of physical and [virtual] asset swaps. 16. Officials were asked for comment on the statement. 17. In our view the statement does not tell the full story. The fuller picture is as follows: It is correct that ETAG, following consideration of submissions, decided to recommend that virtual asset swaps substitute for physical asset swaps. However, a majority in ETAG always favoured including physical asset swaps in the mix of recommendations. The decision not to recommend physical asset swaps reflected a wish for unanimity in ETAG s advice (a minority of ETAG members opposed any physical asset swaps, so the only unanimous recommendation available was for virtual asset swaps). It is also correct that the Minister, after considering ETAG s advice, decided that physical asset swaps (namely the Tekapo A and B transfer and the sale of Whirinaki to Meridian) would provide benefits that virtual asset swaps alone would not

4 However, the Treasury report leaves out the key fact that ETAG was subsequently consulted on whether it agreed or disagreed with the physical asset swaps proposal. ETAG agreed unanimously to the following statement, which is incorporated in the Cabinet paper (paragraph 43) which is the subject of the Treasury report: This combination option [physical and virtual asset swaps] is recommended by the Minister of Energy and Resources. The majority of ETAG support the Minister's recommendation. [Italics added]. The balance agree it is worth serious consideration but wish to draw the potential risks identified in paragraph 31 above to Cabinet's attention in its evaluation of the physical asset swap component. Mount Cook Alpine Salmon 18. The question was raised as to whether Mount Cook Alpine Salmon s current rights in its lease agreement with Meridian will be maintained when Tekapo A and B are transferred to Genesis. The answer is yes. The Ministerial powers of direction to the SOEs is intended to ensure that existing rights and obligations in resource consents and related agreements with Meridian are maintained. At the same time however, it is not intended that contracting parties should be able to better their positions as a consequence of the transfer of the assets. Any such betterment will need to be by way of normal negotiations. 19. MED understands that the Mount Cook Alpine Salmon lease agreement does not provide any rights with respect to minimum water flows. According, if Mount Cook Alpine Salmon wants any such rights it will need to negotiate with Genesis as operator of the Tekapo canals. The comment in the officials report was about this point, but it is not sufficiently clear. This will be corrected. MRP s submission on geothermal assets and virtual asset swaps 20. A Committee member requested further background on this issue. 21. In brief, the Ministerial Review took into account the quantity of generation assets available to SOEs when considering the quantity of virtual asset swaps a generatorretailer could manage without causing it difficulties. Virtual asset swaps are a long term contract which provide a hedge against changes in spot prices. 22. MRP argued that ETAG had made an error in calculating the amount of generation available to it, because ETAG included 100 percent of the capacity of two geothermal plants in which MRP is a joint venture partner. MRP argued that none of the geothermal plant should be included in its asset base (because it does not control the output and contracts of the plant), and that the quantity of virtual asset swaps required from MRP should be adjusted downwards accordingly. 23. MED agrees that 100 percent of the joint venture geothermal plant should not be included in MRP s generation capacity. However, it does not agree that none of the capacity of the plants should be taken into account. MED considers that MRP s ownership share of the geothermal plants is relevant to the judgement Ministers need to make when deciding on the volume of asset swaps. MRP gets a financial benefit

5 from this ownership which offsets its exposure to high spot prices on the retail side, or in hedges it has sold As noted at the Committee meeting, MRP has advised the Minister that it intends to submit a proposal for a revised quantity of virtual asset swaps. (It will need to do so in tandem with Meridian, since the virtual asset swaps are symmetrical on volume and terms). If and when a proposal is received, it will be given consideration by the Minister. Amendments to rows in the officials report 25. Several rows in the officials report have been amended or added (see track-change version). They are as follows: Row 42. (EA s powers regarding investigations, monitoring). Minor amendment to clarify that clause 21 should not apply to investigations. Row 118. (Information disclosure requirements on lines when retailing). Clarification that a requirement to disclose retailed volumes to the EA should apply when volumes exceed 5 GWh/yr on a local network. Row 141a. (Power to regulate charges for supply by alternative means to remote rural consumers). This is an additional provision to pick up cl 5 (overlooked in error) of the Electricity (Continuance of Supply) Amendment Bill as approved by the Commerce Committee. Row 214a. (Restrictions in cl 35(2)(b) on what the Code may contain). Amendment to drafting instructions re ensuring that the Code can include quality standards for Transpower. Row 236. (Addressing potential inconsistency between purpose statements of the Commerce Act and the Grid Investment test). Recommendation changed: drafting changes no longer required. Ministry of Economic Development 26 April The generator asset backing is important because generation and retail are two sides of a see-saw. If spot prices go up, the retail side of the business is worse off (because its costs have gone up) but the generation side of the business is better off (because it gets more spot market revenue). If spot prices go down, the opposite occurs

6 Appendix A: Indicative cost-benefit analysis (economic efficiency effects) of Tekapo A and B transfer All $m NPV Benefits Lower Upper Retail market Generation/storage management 0 24 Sub-total (benefits) Costs Core cost -8-3 Contingency allowance Sub-total (costs) Net position Net benefits (based on core cost) 8 54 Net benefits (with contingency cost) Basis for estimates Retail market Generation/storage management Costs Discount rate NZ retail operating costs are high relative to competitive markets in Australia. A $5/yr cost reduction is assumed (out of ~$170/year in costs), on average, per South island customer in the lower estimate and $10/year in the higher estimate. Separation of Tekapo stations and storage from Meridian will broaden control of hydro storage, creating potential for improved storage management. Difficult to quantify potential benefits. Upper estimate assumes efficiency gain equivalent to 5% of value of Tekapo output. As per earlier papers. See in particular pp 72-3 of the Summary Note on Recommendations Costs and benefits were calculated over a 10 year time frame and discounted at 8% per annum