The electricity industry has to win back its social licence to operate from consumers and politicians tired of excuses about prices rising faster than inflation. Bernard Hickey argues the big five power generators should start by agreeing to create a more liquid wholesale market.

Electricity prices rose 79 percent more than inflation in the nearly 30 years since the state-directed and owned power system was broken up, deregulated and partially privatised.

Nearly a third of New Zealand households now struggle to pay their power bills and most of the children living in poverty are living in homes where the heating is turned off to save money.

Most of this worsening of energy poverty happened between 1990 and 2010 and there have been some improvements since then. The introduction of the ‘What’s My Number’ campaign to encourage competition and changes to the mix of power generation owned by the big ‘gentailers’ helped create more competition and make it easier for people to switch.

But it’s still not enough.

The latest example of the industry’s failure to grasp the nettle happened late last year when wholesale prices more than trebled to record highs. That didn’t affect most household customers immediately because they pay a set price that isn’t directly connected to wholesale prices. But it hit customers of the likes of Flick Electric, who pay the ‘spot’ rate for electricity and then pass that directly on to household customers along with a fee. Their bills skyrocketed through October and November last year.

It all began when the Pohokura gas pipeline had an outage at the same time as hydro lake levels dropped. It meant power had to be generated with coal and other gas, which was then sold onto the wholesale market at near-record highs. Some generators have reported solid profit results and strong dividends over the last week, in part because of these high prices through late October and early November. Some have even started to lift their retail prices in their annual price re-setting exercises.

But it wasn’t just the spot power retailers who were unhappy. Fonterra and other big corporate customers were also grumpy.

The spot retailers complained to the Electricity Authority that the price spike represented an Undesirable Trading Situation. This has a particular meaning under the rules of the electricity market. It refers to collusion or insider trading that is unfair and could reduce confidence in the market. The Electricity Authority is obliged to investigate the trading and the situation when it gets a UTS complaint. 

The authority published the results of its inquiry into this UTS complaint on Thursday and essentially cleared Genesis and the other four big generator retailers (or ‘gentailers’) of colluding or competing unfairly. But the authority also surprised a few in the industry by referring what it found on to the Australian Securities and Investments Commission (ASIC) to investigate. The Australians are involved because the wholesale futures market is on the Australian Stock Exchange.

Make it more liquid

Here’s where the latest flash point in the debate about the amount of competition in the market has gotten the most intense in recent weeks.

Any market needs traders to provide liquidity to be functional and find the most accurate prices. That means some big players agree to buy and sell from anyone at certain rates that they set. This is described as market-making. In foreign exchange and stock markets it’s often banks and brokers that are market makers.

In New Zealand’s electricity market it should be the big generator-retailers, who are on both sides of the market. They can both generate power and sell into the wholesale market and then buy it out of the wholesale market. But at the moment their participation in the ASX futures market as market-makers is a point of contention. They are currently able to pull out whenever they want, especially if the market is seen as stressed.

The problem with that is that the spreads between the bid and offer prices become very wide, and it’s difficult for buyers of these hedge contracts to get a decent deal. The market essentially freezes and becomes useless.

This is also where it becomes a bit political.

The EPR is doing better than the EA

New Zealand First was so upset by the rise in electricity prices it demanded an Electricity Price Review as part of its coalition agreement. Labour and the Greens readily agreed because they were also concerned about high prices and energy poverty.

This EPR has been digging through the various problems in the market and last week recommended that the big gentailers agree to all become market-makers, either in a mandated and compulsory way, or perhaps through an incentive scheme where the industry overall pays for the costs of market-making. Those gentailers include Meridian, Mercury, Genesis, Trustpower and Contact.

However, the Electricity Authority has been much more hands off on this issue and should take a page out of the Electricity Price Review’s options paper, which included a proposal they become mandatory market-makers.

But it isn’t just the outsiders who want to move to having all the big gentailers become market makers. Both Mercury and Genesis want everyone on board, either from a mandate or an incentive based scheme.

Mercury CEO Fraser Whineray complained this week in Mercury’s interim report about the unfairness of not all the gentailers being market-makers, and also of a lack of transparency in the gas market. An outage at the Pohokura field was mostly blamed for the spike in prices.

“We were disappointed with the withdrawal from voluntary ASX market-making by other market participants and look forward to the EA promptly working through equitable improvements to this very important market construct,” Whineray said.

“This is in part related to the gas disclosure issues, mentioned above, which need to be resolved more promptly than is being indicated by the Gas Industry Council,” he said.

This disclosure is a particularly hot topic in the EA report. It found what it called an asymmetric information situation occurred when Genesis knew more about the Pohokura outage than others, and appeared to buy futures heavily to protect itself. Asymmetric is another way of saying one player has more information than the other, and the theory is that the best markets are the ones where everyone has the same information at the same time.

The EA found Genesis had not passed this information on to its traders and that there was no wrongdoing they could see. Genesis also denies wrongdoing. But others in the industry were furious at what they saw as unfair trading.

Whatever the result of the ‘he said, she said’ of this particular case and the ultimate outcome of the ASIC inquiry, the industry needs to get its act together and win back some confidence from politicians, voters and power consumers alike.

The simplest and fastest way would be to provide that liquidity in the market by agreeing to become market-makers.

It would be welcomed by the EPR and consumers alike.

A captured regulator?

The odd one out in this latest flare up is the EA. It has left itself open to accusations that it cares more about protecting the market it invented and runs than looking after consumers. It risks being seen as captured regulator.

When even large market participants that benefit from a less regulated market start wondering if the regulator is too hands off, then we know there’s an issue. A good regulator should do enough to make everyone in the market a little unhappy and give some hope to consumers.

This latest example of a power price spike and the ‘nothing to see here’ regulatory response just further undermined an already endemic lack of trust by the politicians currently in power, along with the hundreds of thousands of consumers preparing for another cold winter.

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