POWER TO THE PEOPLE
Consumers miss out on power savings
THE ELECTRICITY sector has created a big problem for itself: it is rewarding its shareholders more generously than its customers.
Mighty River Power, Meridian Energy and Contact Energy all reported higher profits and dividends this week for their financial years to June. Each achieved its impressive results in slightly different ways, reflecting well on each company’s strategy and execution.
But there were powerful common themes across the sector, which no doubt Genesis Energy will mirror when it reports on Wednesday. These themes seem to defy the logic of efficient markets. Profits and prices should be going down, not up.
First, electricity demand is declining. It fell 1 per cent in the year to June despite the economy growing by about 3.8 per cent. This shows this is a well-established structural trend, not cyclical. Industrial, commercial, agricultural and residential users are all becoming more efficient users.
Even a 4 per cent increase in demand from the Tiwai Point smelter failed to reverse the decline in the past 12 months.
Second, electricity generation is changing. Mighty River and Contact have both started up big new geothermal plants in recent months. In response, Genesis has mothballed equivalent coal-fired capacity at Huntly.
Meanwhile, excellent water inflows in the South Island boosted hydro generation and the new Cook Strait link greatly improved its export to the North Island. In contrast, Mighty River had its worst-ever inflows into its Waikato River schemes so its hydro generation fell but it gained from its new geothermal plant.
Thanks to the increase in hydro, geothermal and wind generation, which have no fuel costs, the companies used less of their thermal generation, which does have fuel costs.
The upshot of all this was Mighty River and Contact generated less electricity and Meridian more than they had in their previous financial years.
Third, wholesale electricity prices continued to ease from their peak in 2012. An exceptionally dry winter then had meant less generation by low-cost hydro plants and more by higher-cost thermal plants.
Wholesale prices now, however, remain higher than they were in 2010 despite falling demand.
Fourth, capital expenditure by the generators is falling dramatically. It will be some years before the sector needs to build any big new plants. If the Tiwai smelter closes in the next few years, the wait will be even longer.
For example, Contact’s capital expenditure was tracking at about $500 million a year 2010-12. It’s down to $230m in the current year and will fall to $100m a year over the next few years. All the generators are enjoying the same lightening of their financial load.
Fifth, the generators’ free cashflow (that is, money not required for reinvestment in the business) is growing briskly. For example, Mighty River’s increased 18 per cent in its past financial year. Contact is forecasting a 10 per cent increase in the current year.
Operational efficiencies, lower financing costs and better mixes of generating capacity are all factors in the sector’s burgeoning cash flow. But the much diminished need to invest in new plant means the electricity companies are generating more cash than they require. Sixth, the electricity companies can choose how to deploy this surplus. They can reward investors through higher dividends and share buybacks; or customers with more competitive prices; or preferably a balance of the two.
Mighty River, Meridian and Contact have picked the first option. They announced this week higher dividends and the prospect of returning capital to shareholders.
In the case of Mighty River and Meridian, their profits and dividends exceeded the forecasts they made when the government floated 49 per cent shareholdings in them in May and October last year, respectively.
These better-than-expected results mean the companies were even better bargains for investors than they seemed at the time.
For example, Meridian’s increased dividend means its shares now offer a 17.6 per cent gross yield on the $1 first instalment for them, versus 13.4 per cent forecast in the prospectus. Fully paid, the shares yield 11.7 per cent gross versus the forecast 8.9 per cent.
These are exceptionally rich returns for investors, given these are utilities that the market normally prices based on a low but steady return.
The losers in this are the government and, ultimately, taxpayers.
The government sold the companies too cheaply; the companies have performed better than forecast; and taxpayers will get only 51 per cent of the upside, even though it was them, not the new shareholders, who bore the risk and funded the development of the companies.
Meanwhile, the electricity companies’ customers are getting less out of all this than the shareholders. Retail electricity prices continue to rise – up 4.2 per cent in the latest quarter – even though wholesale prices are easing and the companies’ profits are rising.
The companies rightly point out that transmission and other costs beyond their control are the biggest drivers of electricity charges. However, the part they control, the direct energy cost, has risen half a per cent a year for the past three years.
They say the retail market is extremely competitive. Thanks to a long-running campaign by the government to persuade people to shop around among electricity suppliers, the churn rate of customers is 20 per cent, which is the highest in the world, Meridian says. This is highly inefficient. It costs the companies a year’s worth of revenue from a new customer to replace a customer lost, according to the rule of thumb in the sector.
But if business was truly this competitive, and the costs of the churn so high, then an efficient market would result in sharply lower prices. Certainly, the companies’ rising profits are giving them scope to cut.
Since the retail market isn’t working, you as a customer can take matters into your own hands. Don’t simply accept offers from electricity companies – hold out for bigger bargains, particularly from your existing supplier. They know exactly how much it will cost them to get another customer if they lose you.
So, investors beware. Market forces will prevail. And if they don’t, then public pressure will ensure the next government, regardless of which party leads it, will reform the wholesale and retail electricity markets to make sure economic efficiency and market forces win in the end.