Reserve Generation

Labour Energy Spokesman, David Parker, is quoted in the paper today defending the Labour government’s decision in 2004 to commission the reserve-generation plant at Whirinaki. Parker says that

there was a need to do something in the short term to get over the problem [of thin generation margins].

The idea of “reserve generation” has always seemed crazy. Electricity generation typically implies relatively high capital costs relative to operating costs, so the idea of commissioning a plant with the express purpose of having it lie idle except in the event of a one-in-sixty-year drought seems extraordinary. Add to that Parker’s view that it was only needed to get over a problem in the short term, then the period over which that capital cost can be amortised is also short.

Let’s do some back of the envelope calculations. According to the article, Whirinaki cost $150m and has been sold 7 years later for $33m, so depreciation costs are approximately 11%. Add in a very conservative 5% opportunity cost on the $150m (nominal interest rate since the purchase and sale prices are nominal), and to get a 16% opportunity cost of capital which equates to $24m per year. Again using the figures from the article, it has operated less than 4% of the time, which is roughly 350 hours per year. Whirinaki has a capacity of 155 MW, so if (another heroic assumption that understates the costs), it was running at full capacity for each of the 350 hours, it would have produced a bit over 54,000 MWh. To cover the capital costs, therefore, this would have required a price of around $450 per MWh in excess of operating costs. The Wolak report estimated that the marginal operating cost for other thermal plants at full capacity to be around $50/MWh, but it is acknowledged that Whirinaki was more expensive than this, so we would need a price of in excess of $500/MWh to enable Whirinaki to cover its costs. And this is without considering maintenance costs and general staffing throughout the year. There is no way that wholesale prices were consistently that high during the period Whirinaki was operating. Of course, this is hardly surprising since no private companies were clamouring to build it based on market prices, and funding had to be through a compulsory levy.

The other statement by Parker that caught my eye was this:

The real criticism that should be levelled here is what was wrong with the so-called “market solution” that left New Zealand short of generation capacity.

There are two quick responses here. First, as above, if New Zealand was genuinely short of generation capacity, why could the government not successfully enter the market and run Whirinaki at a profit rather than through a compulsory levy? Second, if you want to make the criticism that the problem with the New Zealand market in the early years of the century was that we were short of generation capacity, then you must also emphatically reject the conclusions of the Wolak report that claimed $4.3b of market-power overcharging based on an analysis that depends totally for its numbers on an assumption of excess generation capacity in New Zealand. In other words, you can’t say this

“The Commerce Commission report (22 May 2009), based on an in-depth study by Professor Wolak of Stanford University, a world authority, found NZ$4.8b (sic) of overcharging by electricity companies, equivalent to 18 per cent overcharging”, David Parker said.

(For more on why I think the Wolak report is wrong, see Working Papers 11/08, 11/09, and 11/10  here.)

Partial privatisation

Auckland's Professor Tim Hazledine and I argued partial SOE privatisation on Radio New Zealand's Morning Report Wednesday morning, with minor unintentional contributions from a rather vocal Eleanor.


Tim and I are likely around 90% in agreement. We both think partial privatisation a bit of a nonsense; you get little of the potential efficiency benefits of full privatisation but add downside risk. I don't think it will wind up making a ton of difference; Tim puts more weight on the potential downside outcomes. I think we'd both agree that there's more potential downside risk than upside; he'd have the left tail fatter than I would. I think we both agreed that the "foreigners might buy shares" wasn't much of an issue.

Even if we're considering full privatisation, New Zealand's power companies would be reasonably far down on my list. You can make a defensible case that New Zealand's electricity system is one of the world's least screwed up; mucking about with it is risky. The likely equilibrium isn't a private system but rather a regulated cartel industry with more downside risk than upside. Seamus's worries aren't crazy. If I got to choose between DoC selling off half its estate at auction and full privatization of the energy companies, I'd pick the former.

A Justification for Partial Asset Sales

Like most economists, I think, I have been critical of National’s policy to sell off non-controlling stakes in some SOEs. The argument, which I would adhere to in most circumstances, is that either there is a justification for public ownership or there is not—partial sales that allows some private ownership but without injecting the discipline of a threat of take-over would achieve nothing.
In the case of the three state-owned electricity companies, however, there might be a case. The argument is as follows: Vertical integration between the wholesale and retail sides of the electricity market essentially nullifies the market power that in principle would exist in the wholesale market with only four major generators. The close-to-balanced positions that have emerged in New Zealand, with the major gentailers each having roughly the same market share on the demand side as the supply side of the wholesale market removes the incentive for suppliers to restrict supply to inflate the wholesale-market price.

At the same time, however, vertical integration makes the retail market less contestable. If competition between retailers is not as intense as we would like, it is difficult for a new entrant to come into the market, as it would be highly exposed being a buyer and not a seller on the wholesale market, particularly in periods when low rainfall or transmission constraints gave a seller some temporary monopoly power.

Now imagine, however, that a new entrant in the retail market could simultaneously buy shares in the company that was the dominant generator in the region the entrant wanted to sell in. This would be a risk management strategy that would enable it to price to the retail market based on normal wholesale prices, knowing that losses in the event of a high wholesale price would be offset by the return on its shareholdings. Now further imagine that there are strong political reasons why the government would want to retain a controlling stake in the main electricity gentailers. In this case, these two arguments together suggest that maybe sale of a non-controlling stake is the optimal policy.

I’m not sure what I think about this, but I can’t reject the argument out of hand.

Canadian idiots - power price edition

Seamus notes the ridiculousness of exempting electricity and home heating from GST. But it's worse than he's letting on.

Why?

Canadian electricity is already massively subsidized.

Take Manitoba. The current residential power rate is $0.062/kWh. They can export that power to the States. Here's what Manitoba Hydro has to say:

We export electricity into a wholesale market, where customers are largely other utilities. The electricity is delivered at a very high voltage and the utility is responsible for any additional costs associated with supplying that energy to their own retail customers.

A comparison can be made with rates paid by large industrial customers here in Manitoba who, like our export customers, take delivery of electricity at a high voltage and then are responsible for any internal distribution costs.

Wholesale electricity sold to U.S. customers at fixed rates is currently priced 50 per cent higher than what large industrial customers in Manitoba pay.

If Manitoba Hydro can get an export price that's fifty percent higher than the domestic price, then the prices in Manitoba are massively subsidized. This isn't price discrimination that leaves Manitoba Hydro better off; this is just political constraint stupidity.

In a sane state of the world, Manitoba Hydro would charge the same price in the States as in Canada, return a larger dividend to the government, and the government would give bigger transfers to low income households that would leave them better off than under the (cheap power plus lower transfers) equilibrium.

Why is power policy stuck on stupid?

1. Equalization payments mean that the Federal government would claw back additional hydroelectric generation revenues, so the provincial government couldn't use that money to compensate Manitoba low income households;
2. Voters don't understand the first and second welfare theorems. I blame this guy.

So instead of charging Manitobans more, Manitoba Hydro has to pay Manitobans to get rid of old fridges - to do the kinds of things that prices would have induced them to do if we'd only let prices work.

What are the other costs? Manitoba and Ontario use a lot of hydroelectric power generation. In Manitoba, it's pretty much all hydro. Hydroelectric power generation is far less damaging in carbon accounts than is coal-fire generation. Every kilowatt hour that Manitoba cuts back to send to the States is a kilowatt hour that wouldn't be generated by American coal. That's in addition to the obvious screwups you get when domestic power use is subsidized.

Manitobans all smug about how their power use is clean and green need to remember that every bit of power they use means another bit of power is produced by coal south of the border. Your smugs aren't free. There's No Such Thing As A Free Smug.

Electricity "Overcharging" Again

Earlier this month, the Electricity Authority came down on Genesis Energy for overcharing in the wholesale market during a freak 7-hour event on March 26-27 and has retrospectively rest the wholesale price for that period. The price spike, apparently resulted from part of the tranmission network south of Auckalnd being down for a few hours, cutting the far North off from the rest of the grid and giving Genesis an effective monopoly in the North. The spike and resulting angst from buyers was well covered by Matt at TVHE. But what has caught my attention now was the reaction of Labour's energy spokesman, David Parker to the authority's decision.

"The Government will no doubt argue that cutting back the overcharge on this occasion is enough. Labour says it is not good enough. This event is part of a wider problem, and New Zealanders are still paying excessive prices, which the Government defends and allows to continue," David Parker said.

"The excessive prices are yet more evidence of how consumers are overcharged for electricity, and it happened because the lack of an effective competitive electricity market means they can do just that.

"The Commerce Commission report (22 May 2009), based on an in-depth study by Professor Frank Wolak of Stanford University, a world authority, found NZ$4.8 billion of overcharging by electricity companies, equivalent to 18 per cent overcharging," David Parker said.

I have three issues with this:

First, as most New Zealand commentators who have studied the Wolak report have acknowledged (for a symposium of papers on this issue that I have contributed to see here, here, and here), if there have been monopoly rents earned in the New Zealand wholesale market, the amount is nowhere near $4.8b (or even the $4.3b cited in the Wolak report).

Second, it is ridiculous to cite an extreme event where one firm had a temporary monopoly as evidence of a "lack of an effective competitve electricity market".

Finally, while there is an important question of what safeguards (if any) need to be in place to deal with situations where temporary monopolies arise due to transmission constraints, complaining about "greedy" companies, who even with these periods of monopoly are not earning a competitive rate of return on their marginal assets, is a major distraction from the important questions about optimal investment in the transmission network, the incentives of buyers to take out forward cover, the lack of price responsiveness in demand even to predicted extreme events, and so on.