1. Electricity prices have indeed risen significantly in recent years, but so have fuel costs. It would be more sensible to compare power price changes with fuel costs than with the CPI.

2. I’m pleased I was wrong about the weather risk. This has been tackled in 2 ways. One is the $10/household/week penalty for demand reduction campaigns. The engineer’s group IPENZ notes that this “won’t make it rain“, but it does change incentives, and that should have some effect. Quite a neat solution IMHO.

The other tool to address the same problem is the asset swap which will give both Meridian and Genesis a mix of hydro and thermal plant. This is a structural rather than a regulatory solution. Its a low cost option because these are both SOEs. Most tellingly, it is also an implicit admission that the contracts market doesn’t work properly. In principle, these two firms should have been able to (and should have wanted to) contract for exactly the same outcomes as will be delivered by the asset swap. Its a worry that they did not.

I’m keen to see where the electricity review process goes. There are so many different parts to this industry, each of which has its own issues, that target selection is a major issue for any review. On the bright side, this means that we will learn something about the deciders by inspecting their choices. (hopefully they will be less emotional than The Standard )

Some choices are obvious, low hanging fruit just begging for attention. Untangling the bureaucratic mess of grid regulation, for example, would be great progress and would also burnish the government’s deregulatory credentials.

At the other extreme are arcane make-work schemes for consulting economists, like financial transmission rights. Lets hope the review process does not end up down this blind alley, at least not unless it has already tackled the elephant in the room (see below).

In between, but still missing the point, is Frank Wolak’s study for the Commerce Commission, where he estimates a gap of  $4.3bn between actual wholesale prices and perfectly competitive prices. There is debate about Frank’s treatment of water values, and there should be some debate about his use of price-cost margins, but the main problem is that he compares our actual real market against an unrealistic benchmark world in which prices reflect marginal cost. Since the Commission has not launched proceedings, it must believe there is no persuasive evidence of collusion between generators. So Frank’s study is really just valuing, in wholesale electricity, the difference we know to exist in all markets between workable and perfect competition. It totally begs the question of what, if anything, to do.

As always, problem definition is the key. That damn elephant can be surprisingly difficult to see. Personal view: the weather. Leaving aside the odd (embarrassing but surely fixable) grid failure, the electricity industry stays below the public/media radar pretty well except when we have dry cold winters or look likely to have them, as in 2001, 2003 and 2008.

These are stress periods because NZ relies heavily on hydro power but we don’t have much storage. In aggregate, we use more power in winter than summer, so if the southern lakes are low in autumn, the system starts looking stretched.

The spot price signals these perceptions early as firms price in higher probabilities of shortages occurring during winter. Prices spike, signalling scarcity, and those buyers exposed to higher prices respond by looking for ways to cut demand. These are efficient responses, the value of which is clearly signalled by the market. So the market mechanism works well under stress.

Cue bizarre conversations where economists try to explain that the market is working very well and everyone else wants to know why it needs to work so well, i.e. why are we short of power? Everyone knows we are short of power because there are also public campaigns encouraging us to use less. In winter, when we need it most. It is just downright embarrassing. What kind of competitive electricity industry are we running if government agencies need to initiate &/or fund these appeals to collective, socialist sentiments every time the weather turns against us?

And what about all those firms producing tradable goods and services with electricity as a significant cost? Why is it that they are now implicitly forced to take a bet on the weather through their choice of electricity contract? Isn’t it bad enough they have to bet on the dollar?

This is the dilemma the review needs to address: weather risk. I can see two ways of tackling this problem. One is to recruit more price-responsive demand that might lessen the need for campaigns; the other is to build standby or other hydro-firming generation capacity so that we can mitigate/avoid weather risk.

While I sincerely hope to be proven wrong, I doubt we’ll see much progress in either of these directions. There are several connected reasons. First, in its 13 year history, the market hasn’t delivered on either of them, so its safe to conclude they aren’t attractive business opportunities. It follows that progress in these directions would be costly to the industry, and would probably need to be enforced by law/regulation, or at least the threat thereof. Put alongside this the fact that the government owns most of the generation sector, is strapped for cash, and may be inherently averse to regulatory intervention.

So unless Bill English can find a few hundred million each year to plug the budget, Gerry Brownlie might just have to stay nervous about the weather.