The controversial Commerce Commission report into wholesale electricity market power has drawn surprisingly strong criticism from local analysts. As previously reported in NZ Energy & Environment Business Week, the central issue is the value placed on stored water for hydro electricity. The recently released analysis by Stanford University electricity market expert, Professor Frank Wolak, used a Californian model to price water, which both the University of Auckland Energy Centre and local energy market services provider Energy Link say is plain wrong. The Energy Centre says “it ignores NZ’s likelihood and resulting cost of running out of water. Whereas California always has the option to import electricity from other states, NZ faces rolling blackouts and considerable economic losses if hydro lakes run out of storage.” Wolak used a study which made no estimate of shortage costs, “yet these shortage costs are likely to be higher than the marginal cost of thermal generation. If this is correct, then the Wolak report overstates the amount of market rents during dry years.”

Wolak’s calculation NZ power companies had “overcharged” consumers by $4.3bn between 2001 and 2007 provoked deeply negative media coverage and provided Energy Minister Gerry Brownlee with a platform to promise potentially substantial changes to electricity market arrangements. Yet Greg Sise, CEO of Energy Link says Wolak had made no allowance for “creating incentives for investment for new generation capacity or for anywhere near normal returns on investment capital. The $4.3bn estimate of market power rents is comparable to the total pre-tax profits of the four major generators, which begs the question: if gentailer profits were slashed by 90%, what incentive would there be to invest in new generation to cope with steadily increasing demand? This question is not answered in the Commission’s report.”

These two critiques echo investment analysts at the broking firm Forsyth Barr which calculates electricity company rates of return over the period in question at an average 7.2% annually, compared with a target weighted average cost of capital of 9% for the sector. Shorn of the alleged overcharging, the rate of return falls close to 3%, well below an acceptable commercial return.

Meanwhile, Electricity Commission Chair David Caygill says the EC is sharpening its focus to three areas, as it integrates its own Market Design Review, the Winter 2008 Review, and the Wolak/Commerce Commission findings. This is to “ensure a sharp focus is kept on work which potentially has higher value in terms of constraining prices, strengthening price signals and enabling competition.” The EC nominates capacity and scarcity pricing, the future of Whirinaki, and locational hedges as the three key areas of most beneficial focus.

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