The Economic Effects of the Price-Discriminating Single Buyer Lewis Evans Professor of Economics

1. The Economic Effects of the Price-Discriminating Single Buyer Lewis Evans Professor of Economics Victoria University of Wellington Research Fellow, NZ Institute for the Study of Competition and Regulation Prepared for the VUW IPS Seminar on the Greens-Labour proposal for the Electricity Market 4 July 2013, Government Buildings, Victoria University of Wellington (http:iscr.org.nz)

2. Overview • How the electricity market works • The price-discriminating single buyer plus taxation proposal • The short term effects • The the longer term effects • The wider effects

3. Electricity: NZ-specific issue 60% is hydro generation with limited storage and very volatile water supplies

4. Electricity: NZ-Spot Electricity Prices • Transactions occur largely at the fixed hedge price • Generators are short of water in dry years • The high price episodes do not imply market power or rent to generators The spot electricity price = value of unit of stored water Spot market is a nationwide water market

5. We observe no dry-year generator cash profit humps Generators and buyers can each win and lose with dry weather What we observe is fully consistent with a workably competitive market

6. NZ Electricity: 2013 Energy only Market, no taxpayer-as-taxpayer- funded investment, risks assigned to those best able to manage themHouseholds produce the peaks Oligopoly: 5 large firms + fringe competition: workable competition. Generation 1/3 households and 1/3 commercial firms & 1/3 large industrials (Retail) Customers (National HV Grid) Natural monopoly SOE (investment/prices regulated by the Commerce Commission) Transmission (Local LV Grid) Natural monopoly (cooperatives/regulation Commerce Commission) Distribution

7. Many Buyers & Sellers • 14 retailers (4 not gentailers: 22 brands) • Generation • Greater than 1MW: there are 140 plant owned by 36 separate companies (operated by 19) • Less than 1MW: small (at least 80, micro plant embedded in networks) • Traders spot: 32 distinct buyers or sellers (plus some “demand” sellers) • Traders ASX: 12 distinct traders: 5 of which are not market participants (risk managers) Source EA June 2013

8. The Hedge/Contract Market Evidence is that hedge price closely approximates next cheapest generation option: as it should This is the cost of electricity to New Zealand

9. The Market is Producing Normal Profits • Accounting profits are • determined by price set in the market and productivity not vice versa • As in many other industries Accounting profits are not economic profits: e.g. accounting profits assume that water is free: it is not economic profits are what is of value to society There is no evidence of systematic profiting from market power or that economic profits are abnormal

10. The Single-BuyerPrice-DiscriminationSimply a transfer from households-as-taxpayers to households-as-electricity-consumers • Takes revenue from the government as owner of generators and recipient of taxes • Takes revenue from private individual owners by lowering dividends • It therefore raises taxes to pay households for electricity consumption • It is a tax-transfer scheme by definition

11. The Single-BuyerPrice-Discrimination Tax-Subsidy SchemeEconomic Effects I: in the short term • It does not lower the cost of electricity: it lowers the price of electricity to (some) households funded by taxation (cf education subsidies) • Any effect on economic activity will be purely a re-distribution tax/subsidy effect • It will increase electricity demand to excess: beyond that justified by its social cost to New Zealand

12. The Single-BuyerPrice-Discrimination Tax-Subsidy SchemeEconomic Effects II: it is bad for the environment • It encourages excess electricity consumption, and electricity production has external environmental effects: hydro, gas and geothermal • It reduces alternative, relatively cost efficient (environmentally friendly) ways of supplying household energy: solar, micro grids, insulation, direct gas etc etc • It violates the economic law of one price ( all users/uses should pay the same price for exactly the same good otherwise there is social benefit in adjusting use) The ETS scheme is based on this law

13. The Single-BuyerPrice-Discrimination Tax-Subsidy SchemeEconomic Effects III: it centralises decisions • Presently • multiple buyers and sellers allocate risk among themselves according to their capability and effect • Water is allocated in society’s interest for electricity and the wider economy • Proposal • Operational controls will extend down to generation/demand decisions: • Single buyer is also single seller: who chooses risk allocation and specific prices • Result: centralised management where competition is possible: generally • produces discrimination in process and activity and • relatively poor use of resources.

14. The Single-BuyerPrice-Discrimination Tax-Subsidy SchemeEconomic Effects III: in the longer term • A major objective of the scheme is to reduce accounting profits. What private entity will invest? • Very likely that the government will be source of future generation investment, implying even higher taxes • It will create a politically controlled state organisational silo in lieu of competition and wide (democratic) participation in delivering electricity to meet society’s demands

15. The Single-Buyer Price-Discrimination Tax-Subsidy Schemeit is not just relevant to the electricity market but to the wider economyWhat problem is it trying to solve? • It is a tax-subsidy scheme to households for electricity: • It need not dismember the electricity market as well • What are the equity issues of the proposal? They relate only to any tax-electricity-subsidy transfer: should electricity be subsidised vs other public/private expenditure? • It • “takes” from private investors without compensation (presumably). • It strands alternative energy saving investments of households, and local generation. • It implies that competition and de-centralised, participatory decision-making may not well be the way of the NZ future: • In a very wide range of industries/activities. • It has implications for NZ on the world stage.

16. The Single-Buyer Price-Discrimination Tax-Subsidy Scheme Many of the economic characteristics/effects are not fixable Thank you for your attention

17. Some References Lewis Evans, Graeme Guthrie and Angela Lu, “The Role of Storage in a Competitive Electricity Market and the Effects of Climate Change”, Energy Economics, 36, 2013, 405-418. Lewis Evans, Seamus Hogan and Peter Jackson, “A Critique of Wolak’s evaluation of the NZ electricity market: introduction and overview”, New Zealand Economic Papers, 46(1), 2012, 1-11. Introduction to a symposium of several papers on Frank Wolak’s Commerce Commission consulting work. Lewis Evans and Graeme Guthrie, "How Options Provided by Storage Affect Electricity Prices”, Southern Economic Journal, 75(3), 2009, 681-702. Lewis Evans and Graeme Guthrie and Steen Videbeck “Assessing the Integration of Electricity Markets using Principal Component Analysis: Network and Market Structure Effects”, Contemporary Economic Policy, 26(1), 2007, 144-161. Lewis Evans and Richard Meade, Alternating Currents or Counter-Revolution?  Contemporary Electricity Reform in New Zealand, VUW Press, 346pp., 2005. Various notes and presentations on electricity: New Zealand Institute for the Study of Competition and Regulation: www.iscr.org.nz. Lewis Evans and Neil Quigley, “ Compensation for the Takings of Private Property Rights”, ch.12 of Modern Challenges of the Rule of Law, Richard Edkins ed., LexisNexis, Wellington, 2010, 233-263.