18 Sep 2001
Infratil today released a newsletter for its shareholders reviewing the electricity sector and the lessons from the winter of 2001. Infratil's newsletter comments that 2001 was dry, with total inflows over the first seven months of the year the driest in the last 71 years.
Infratil believes the Government handled the crisis well and that the calls for conservation by consumers were appropriate in the circumstances.
Infratil's analysis looks at the market and how well it is serving New Zealand. Infratil believes that the industry structure has many problems and that it is failing to deliver on many of the goals set for it.
Infratil's observations are:
Infratil considers that we have forgotten why we created the market - to get the taxpayer out of taking investment risks with as little loss of operational co-ordination as possible.
As Infratil put it in the newsletter 'The score sheet on the market is struggling for a restricted pass mark'.
Infratil considers the market design itself is not fundamentally faulty but further structural reform is needed. Infratil spokesperson, Dr Bruce Harker, said, 'At the moment we have all the costs of running a market but the market structure needs further reform if we are to get the benefits. In a small market such as New Zealand's, you need all the pro-competitive, pro-liquidity, structural reform as you can get to make the market framework worthwhile'.
Dr Harker said 'The New Zealand market falls short of a competitive model as there are only a small number of generators and it is a small market. In a market like New Zealand's, generators will plan to supply their contract obligations and price up the surplus to improve what they can earn on the spot market, also encouraging customers to pay more for contracts. In a dry year with low levels of contracts, this pricing up of uncontracted generation means hydro levels fall further and prices have to rise further before this plant generates fully. This is what happened in 2001. This means that dry year security of supply is related to how customers contract and that the risks of being uncontracted are high for power purchasers. The market should deliver good dry year security if customers contract to match their needs for reliable supply.
These features of the New Zealand market means all the focus on how well it works needs to be placed on ensuring as much competition in the contracts market as possible and that means as much tradability and liquidity as possible.
Vertical integration and regional market fragmentation of the contracts market are major barriers to New Zealand having an effective contracts market.'
Generation interests now completely dominate the sector. With the primary purpose of generation companies being to build new power stations this can hardly be the best structure for the promotion of energy efficiency or innovative retail pricing. The real question is, do generators really want to see this form of price signalling develop? We suspect generators would rather encourage consumption and build power stations than have consumers respond.
Infratil's prescription for structural reform includes:
Reducing the vertical integration in the sector. Infratil would like to see the State divest its retail electricity businesses to improve contract liquidity and spur retail innovation.
Require further divestment/separation of SOE generation assets to improve competitiveness in the all important contracts market.
Establish transmission cost hedging instruments as an urgent priority to facilitate a national market with nationally tradable contracts.
Together these measures would move the industry forward and ensure net benefits from the market reforms and create a more stable investment climate for the private sector. Infratil believes the market needs these reforms if it is to provide an efficient market to underpin New Zealand's economic growth.
Specifically commenting on Infratil's investment at TrustPower, Infratil sees TrustPower as being a short term beneficiary of the industry's consolidation to less competitive structures with:
Essentially, Infratil sees the bulk of TrustPower's longer term value as being its hydro and renewable energy wind developments. The value of these is driven by gas prices post Maui and by emissions related costs for price setting new thermal power stations.
The structural problems in the market are however a concern for Infratil as the combination of poor structure and State dominance create distortions that will ultimately need to be addressed. Infratil would prefer a more robust and sustainable commercial structure. The alternative to further structural reform is an approach of adhoc regulatory interventions, which are in Infratil's view likely to fail and prolong the structural problems in the market.
For a copy of the full September newsletter click here (PDF 917kb).
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