Ex­cess prof­its for en­ergy gen­er­a­tors over seven years

DEMM Engineering & Manufacturing - - NEWS -

A NEW re­port by a Univer­sity of Auck­land econ­o­mist has found that in the seven years from 2010 to 2016, power gen­er­a­tors pock­eted an ex­tra NZ$5.4 bil­lion in prof­its over and above what they would have if the whole­sale elec­tric­ity mar­ket was truly com­pet­i­tive – equat­ing to 36 per­cent of rev­enue.

Dr Stephen Poletti, a se­nior lec­turer in en­ergy eco­nomics at the Univer­sity of Auck­land Busi­ness School, used com­puter mod­el­ling to sim­u­late how en­ergy traders in gen­er­a­tor firms be­have in the whole­sale mar­ket, and com­pared it to how they would be­have if the mar­ket was com­pet­i­tive – that is, if gen­er­a­tors were forced to al­ways sell power at cost. The sim­u­la­tion also fac­tored in hy­dro dam wa­ter level data.

He demon­strated that the model was re­li­able and ro­bust by check­ing sim­u­lated prices against ac­tual prices. The model showed that ‘mar­ket power rents’ – the ex­cess prof­its that gen­er­a­tors are able to make – are “sub­stan­tial” – to­talling NZD5.4 bil­lion over seven years or 36 per­cent of rev­enue. This is sim­i­lar to or higher than those found by Stan­ford econ­o­mist Pro­fes­sor Frank Wo­lak, Work­ing Pro­fes­sor of Com­mod­ity Price Stud­ies in the Depart­ment of Eco­nomics at Stan­ford Univer­sity in Cal­i­for­nia, in 2009.

“It’s ex­ces­sive, and we also know from the Elec­tric­ity Price Re­view and other work that en­ergy re­tail­ers are mak­ing ex­ces­sive prof­its, too,” says Dr Poletti. “We should re­design the elec­tric­ity mar­ket so that the prof­its are less and peo­ple pay less for elec­tric­ity.”

( The in­de­pen­dent price re­view found that New Zealand house­holds are pay­ing 79 per­cent more for power than they were in 1990 when ad­justed for in­fla­tion.)

Cur­rently, traders in this coun­try’s five gen­er­a­tor com­pa­nies ‘bid’ on sup­ply­ing cer­tain amounts of power into the whole­sale mar­ket. This bid­ding op­er­ates a lit­tle like a dead­line sale in real es­tate, ex­cept the drive is to­wards higher not lower prices: each bid­der is blind to other bids, so the trick is to set the bid as high as pos­si­ble but not so high that you are un­der­cut by other bid­ders.

In­stead, Dr Poletti prefers a sys­tem like the one used in PJM, a firm that co­or­di­nates the move­ment of whole­sale elec­tric­ity in Penn­syl­va­nia, Jersey and Mary­land. “In the PJM sys­tem, gen­er­a­tors have to bid in at cost of pro­duc­tion,” he says. “This would lower prices for con­sumers. If prices are too low for new in­vest­ment to meet fu­ture demand growth, long-term con­tracts for new gen­er­a­tion could be auc­tioned off.”

Other op­tions in­clude a price cap or a ‘sin­gle buyer’ that would ne­go­ti­ate long term con­tracts for dif­fer­ent types of gen­er­a­tion re­flect­ing their cost struc­ture, he says. In par­tic­u­lar, the cap­i­tal costs for hy­dro dams paid for by tax­pay­ers decades ago have long since been re­cov­ered. “The run­ning costs for hy­dro are close to zero, which would be re­flected in the low con­tract price of­fered by the sin­gle buyer.”

Dr Poletti also ob­served that the low­est bids (close to zero) across all gen­er­a­tors are con­sis­tently close to the level of demand, how­ever the price is set by higher price bids for the last few megawatts of demand. He says he would next like to in­ves­ti­gate whether there is “tacit col­lu­sion” be­tween gen­er­a­tors such that, taken to­gether, they avoid of­fer­ing too much low cost supply what­ever the state of demand.

Dr Poletti’s re­port - Mar­ket Power in the NZ whole­sale mar­ket 2010-2016 – notes that the New Zealand elec­tric­ity mar­ket is one of the least reg­u­lated mar­kets in the world. “The ex­tent of mar­ket power in the… whole­sale mar­ket is clearly a con­tro­ver­sial topic... it is timely to re- ex­am­ine this is­sue.”

The pre­vail­ing view in New Zealand is that ex­cess prof­its are needed to re­cover in­vest­ment costs in gen­er­a­tor plants is “one that we haven’t seen ex­pressed by reg­u­la­tors in other elec­tric­ity mar­kets”, the re­port says.

“The ar­gu­ment can of course be turned on its head. Mar­ket power rents… may have en­cour­aged ex­ces­sive in­vest­ment that has led to an over­sup­ply of ca­pac­ity.

“The hy­dro plants were built and paid for by tax­pay­ers years ago – they don’t need to make any ex­tra money to cover build­ing costs, and main­te­nance costs are very low at around $5-10 per megawatt hour, com­pared to the av­er­age mar­ket whole­sale price for hy­dropower of $70.”

Prof. Wo­lak’s re­port, done for the Com­merce Com­mis­sion, was crit­i­cised at the time by aca­demics and pol­icy-mak­ers for the way it as­signed value to the wa­ter used in hy­dro dams, among other things. Dr Poletti’s re­port de­scribes many of the crit­i­cisms as “ten­u­ous [and] used to jus­tify the pre­vail­ing mar­ket ar­range­ments”. His mod­el­ling fac­tors in wa­ter val­ues ro­bustly, he says.

“It is true that whole­sale prices have sta­bilised or gone down a bit in the past few years – partly be­cause of a lot of low- cost supply com­ing in like geo­ther­mal. But they’ve sta­bilised at a high level, and they’re much higher than they should be if the mar­ket was com­pet­i­tive,” he says.


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