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Electricity Supply and Poverty in New Zealand

Geoff Bertram

The electricity industry in New Zealand provides a good case study of how a neoliberal ideological agenda plays out when harnessed to the attitudes and practice of modern big business. At the beginning of the neoliberal period, the industry was a publicly-owned, democratically accountable provider of an essential public service. Its aims were social ones: electricity was supplied, and priced, for the primary benefit of the population at large, whose taxes, rates, and payments for power had funded the construction of an integrated, sophisticated engineering exercise intended to underwrite living standards and economic development. Engineers designed and ran the system, while elected people at local and national level were accountable for its performance.

On many fronts this offended neoliberal principles. Government was running a successful non-profit operation in a key sector of the economy where big profits potentially beckoned. Engineers preferred to play safe with plenty of backup capacity and cautious use of the available water resource, where profit-driven entrepreneurial types saw room for greater risk-taking. The New Zealand Treasury resented NZED’s ability to secure large chunks of public funding for projects which it considered not sufficiently cost-effective. The organisation of electricity supply was completely at odds with neoliberal views about the superiority of private ownership and corporate governance. The sector’s transparent, cashflow-based accounting procedures were easily understood by ordinary people, but frustrating to the accrual accountants and PR specialists who have since 1990 transformed the sector’s disclosure statistics and annual reports into a glossy information minefield that is impenetrable to the general public. A rising generation of opportunistic financial entrepreneurs was straining at the leash for the chance to loot the public sector’s huge asset portfolio. And of course the tight control of final prices in the face of occasional excess demand offended against the neoliberal instinct for deregulation to allow market forces to prevail.

Once given their head to transform the sector, the neoliberal policymakers of the late 1980s and the 1990s threw overboard the whole notion of “essential services”. Electricity, they said, was just like baked beans – a commercial product whose supply could be commercially organised in a market system built around the profit motive and free of any but the most minimal regulatory control. Advocates of this view were blind to the special features of electricity that make it quite unlike baked beans: the need for supply to be constantly coordinated and planned by a central system operator, the impossibility of storing the product, which must be supplied at the same time as it is used, and the synergies amongst the component parts of the vertically-integrated supply chain that are lost when the industry is broken into separate enterprises.

The restructuring route followed a clear sequence: corporatise, deregulate, rationalise, and privatise. Nearly three decades into the process, by 2014 only the first of these has been fully accomplished; the other three remain contested. The promised genuinely-competitive market remains a mirage on the horizon, as a de-facto cartel of five giant generator-retailers keeps a stranglehold on the wholesale and retail markets, while a tame token regulator rubber-stamps the steady upward creep of lines charges[1].

For ordinary people the outstanding result from corporatisation and deregulation has been rising prices. A collateral result of inexorably rising prices has been the emergence of growing energy poverty among low-income households as their electricity bills have taken a growing share of already-constrained family budgets. Converting everything into 2014 dollars using the consumer price index, the average price of delivered electricity for residential customers back in 1985, before corporatisation, was 13.28 cents per kilowatt-hour. By 2014 it had doubled to 27.59 cents per kilowatt-hour[2]. Over the last twelve years from 2002 to 2014, the residential price rose in real terms by 42%, from 19.61 cents/kWh to 27.59 cents/kWh, an increase of 7.97 cents, of which 1.93 cents was accounted for by increased lines charges, and 6.04 cents by increased charges for “energy and other”[3] – basically, the five big gentailers’ revenues from generated electricity and their ballooning retail margins.

Not all electricity users suffered to the same extent from the neoliberal project. Large industry, represented by the well-resourced Major Electricity Users’ Group (MEUG), successfully wielded countervailing power against the electricity suppliers, holding industrial prices steady. In 1985 the average electricity price to industry was 10.54 cents/kWh; in 2012 it was virtually unchanged at 10.57 cents/kWh. Commercial users, meantime, saw their average price fall in real terms from 20.85 cents/kWh in 1985 to 14.53 cents/kWh in 2001, before climbing back to 17.19 cents/kWh by 2012.[4] The burden of neoliberal policy fell almost entirely on the most powerless and undefended group of consumers – residential customers.

No credible official explanation for the steady price squeeze on residential electricity users has ever emerged. For many years there was talk of the need for prices to rise to fund new power station construction, and more recently the substantial cost of rescuing the Transpower grid from collapse after two decades of neoliberal-driven neglect has been blamed for ongoing price increases. But these general claims do not explain why residential consumers should have been the sole victims of price-gouging. In 1985 residential consumption of electricity was 37.4% of total sales volume, and revenues from residential sales were 43.7% of the total. By 2011 (the last year for which published statistics are available) residential consumption was 33.6% of the total while revenues from residential consumers accounted for 50% of total revenues.

The current Government, and the Electricity Authority, have in effect blamed residential consumers for the price increases they have suffered. The “what’s my number?” campaign, arguing that it is up to consumers to reduce their electricity bills by actively bargaining and switching suppliers, has shifted the onus for market price trends away from electricity suppliers and onto customers. This notion that “competition” in a market has to be created by customers, rather than emerging from vigorous market forces on the supply side, reveals the bankruptcy of neoliberal thinking in the face of electricity market realities. Genuinely competitive markets give consumers the lowest possible prices as a matter of course – not as some eternally-unfulfilled promise, towards which consumers have to strive day and night at substantial personal cost in terms of time and energy.

To gauge the extent to which the corporatised and deregulated New Zealand electricity market has delivered windfall gains to suppliers – both privately and state-owned companies – it is instructive to look at the market valuation of the fixed assets: dams, power stations, transmission and distribution lines and transformers. Possession of these assets confers market power, which translates into ability to extract cash from captive residential consumers. Working back from cashflows, the so-called “fair value” of the assets is a matter simply of calculating the discounted present value of the future stream of profits attributable to each asset or set of assets. If customers are charged no more than is required to provide a reasonable return on the actual historic cost of assets, then asset “fair values” will remain stable unless interest rates (hence discount rates) change. If asset “fair values” are rising, this is indicative of either falling discount rates or revenues in excess of those required to sustain the industry. Over the two decades up to the Global Financial Crisis, New Zealand interest rates showed no long-term trend, which means the asset revaluation trends discussed below were driven mainly by revenue.[5]

In the 1990s, before the old Electricity Corporation of New Zealand (ECNZ) was broken up and part-privatised, its fixed assets were carried on the books at a valuation of a little under $5 billion. By 2013 the five generating companies that had taken over the bulk of those assets – Contact, Meridian, Mighty River, Genesis, and Trustpower – were carrying their fixed assets at a combined valuation of $23 billion[6]. The historic cost of the assets – the cost of purchasing them from ECNZ, plus the cost of all subsequent investment in new plant, adjusted for depreciation – was $13 billion. Thus the five companies over the period 1999-2013 added roughly $8 billion (the difference between $5 billion and $13 billion) to their fixed assets by actual cash outlays on investment in new equipment, but added an additional $10 billion (the difference between $13 billion and $23 billion) by revaluations to “fair value”. The assets were, in short, returning far greater profits than would have been required to sustain their value in line with historic cost.

Similar observations apply to the distribution lines companies. In the early 1990s before corporatisation and deregulation, the fixed assets of the old Electricity Supply Authorities had total book value of nearly $2 billion. By 2011 the book value of fixed assets was over $8 billion. Of the $6 billion increase only $2 billion can be accounted for by net new investment; the remaining $4 billion represents cumulative asset revaluations, mostly undertaken between 1994 and 2003 when the lines sector was completely unregulated and the Government cheerfully accepted the writing-up of asset values to equivalent replacement cost (the so-called “optimised deprival value”, ODV). The current asset values are calculated from the ODV values in 2004 (when the Commerce Commission was given the task of regulator) adjusted for subsequent investment and inflation; lines charges are set, with a mandate from the regulator, to provide a market rate of return on the total book value.

Adding together the asset revaluations in generation and distribution gives a total of $14 billion of asset value that has not been secured by either purchase or new investment – it has been created by pricing practices and accounting devices that utility regulators in other jurisdictions would not have countenanced.   The 2013 Labour-Greens proposal to force generators to write down their assets to historic cost, and to trim their prices and revenues accordingly, was targeted at this.

Once one starts thinking about the economics behind the asset valuations, the issue of how hydro dams are to be valued comes quickly to the fore. Dams are landscape features quite unlike most industrial capital. They have only one high-value use, which is the capture of water (mainly for electricity generation, but sometimes for irrigation and other purposes also). The cost of building them was sunk long ago, and what economists call their “transfer earnings” (the amount that must be paid to their owners to keep them available for electricity generation) is effectively zero. Their disposal value to other sectors of the economy – the amount a dam might fetch if sold off to a bidder not involved in electricity – is extremely low (imagine rowing clubs bidding for Karapiro, for example). Consequently, the very large sums of money the owners of hydro dams recover from the present electricity market are basically windfall rents, which perform no economic function other than to prop up the value of the businesses. The great bulk of rents can be taxed away, or negotiated away, without causing the asset to be withdrawn from service.

This means that if the owners of New Zealand’s hydro dams were forced to enter into long-term contracts to sell electricity at a price that covered just the operation and maintenance costs of their dams, plus some modest margin, they would still continue to supply electricity as before. Passing through the benefits of these contracts to final prices could make a big difference to household electricity bills. Labour and the Greens in 2013 proposed the imposition of a “single buyer” for wholesale electricity, which would hold contracts of this sort and distribute the benefits to residential consumers. The model resembles the supply arrangement for the Tiwai point aluminium smelter, which has for many decades paid a special low electricity price based on a long-term contract. Similar proposals for a long-term contract arrangement to hold down the price of electricity from old hydro dams were put forward at an early stage of electricity market restructuring[7] but were rejected, partly at least because of the Treasury’s hunger for more revenue from state-owned enterprises, (whether secured over time under state ownership or in chunks via privatisation).

An alternative way to capture and redistribute the functionless rents currently falling into the laps of hydro dam owners would be to charge them for the water they use, since without the water the dam structures would have no value of any sort other than their scenic character. The questions of who exactly owns the rain that falls on Aotearoa-New Zealand, and at what point any sort of ownership right applies, are challenging, but may well become central to future policy on the pricing of electricity.

In a modern economy, the supply of electricity is an essential service that underpins living standards. From the early twentieth century until the mid 1980s, New Zealand Governments were committed to harnessing the country’s natural resources – hydro, geothermal, coal and gas – to provide affordable electricity for households and industry. The construction of the giant power stations, the national high-voltage grid, and (on a smaller scale under local government) the local distribution networks, were collective public-works projects with collective payoffs. As Adam Smith put it in his Wealth of Nations, one of the duties of the sovereign is “erecting and maintaining those public institutions and those public works, which, though they may be in the highest degree advantageous to a great society, are, however, of such a nature, that the profit could never repay the expence to any individual or small number of individuals, and which it therefore cannot be expected that any individual or small number of individuals should erect or maintain” (Smith Book V Part III).

Once built, the electricity system was operated on a non-profit basis to meet social objectives. Electricity charges were set to cover operating costs and amortise investment costs – but not to return a commercial profit on the assets. Many of the assets – particularly dams – became, once constructed, permanent features of the landscape. They were useful for only one purpose – producing and distributing electricity – and so they had (and have) “value” in an economic sense only when used for that specialised purpose.

Electricity Supply Authorities – the retailers – bought electricity from the old NZED, and later from ECBNZ, at a “Bulk Supply Tariff” that was set to cover the costs of generation and transmission. They added on the costs of their local networks and a tiny margin for retail costs, and recovered the resulting total by charging three customer groups: residential, commercial/light industrial, and any large industries that might take power from the local network. (The very largest industries, such as the Comalco/Rio Tinto aluminium smelter took their power directly from the grid and paid NZED/ECNZ.) Pricing policies were attuned to social needs and to the political power enjoyed by residential customers as voters for both local and national government. Hence residential prices were lower than those for commercial/light industrial users, and comparable with the amounts paid by large industry. There is no evidence that this implied any cross-subsidy, because a large part of the revenue secured from customers went to pay fixed overhead costs the allocation of which across different customer groups is arbitrary (a matter for political decision).

 


 

 

[1]

On the consolidation of the gentailer cartel see Geoff Bertram, “Weak regulation, rising margins, and asset revaluations: New Zealand’s failing experiment in electricity reform”. in Evolution of global electricity markets: new paradigms, new challenges, new approaches, edited by F.P. Sioshansi, Amsterdam: Elsever Academic Press, pp.645-677, 2013, link. For discussion of the history of Commerce Commission oversight of lines charges see Geoff Bertram, “Light-handed regulation of the energy sectors”, CAFCA Watchdog 135, April 2014, pp.13-29, link; and Geoff Bertram and Dan Twaddle, “Price-cost margins and profit rates in New Zealand electricity distribution networks since 1994: the cost of light handed regulation”, Journal of Regulatory Economics, 27, 3 (2005), pp. 281-307, link.

[2]

MBIE, Energy in New Zealand 2014, link, p.60, and supporting table at link Figure F10,accessed September 2014.

[3]

Figures are from MBIE, Residential sales-based electricity prices March year 2002 to March year 2014, accessed September 2014. download spreadsheet

[4]

MBIE, Data tables for prices, worksheet “Annual cents per unit real”, accessed September 2014. download spreadsheet

[5]

There was also a change after 2006 in accounting practices linking deferred tax to asset revaluations.

[6]

Figures compiled from company annual reports.

[7]

Geoff Bertram, Ian Dempster., Stephen Gale and Simon Terry, Hydro New Zealand: providing for progressive pricing of electricity Wellington: Energy Reform Coalition, 1992.

Categories: Economic policy, Poverty
Geoff Bertram
About the author

Geoff Bertram

Senior Economist - Victoria University

Dr. Geoff Bertram, a Doctor of philosophy graduate from Oxford and a long-serving senior economist at Victoria University Wellington has been at the forefront of economic policy writings and discussions for many years. His research interests include the regulation of public utility industries such as electricity, gas and telecommunications; the economic and political development of small island societies with a particular focus on the Pacific; the design of policies to address climate change; and the long-run evolution of the New Zealand economy.

Dr. Bertram has over 100 publications including more than 50 peer-reviewed journal articles, books, and book chapters. He served on the Council of the International Association for energy Economics from 2005 to 2007 and convened the Association’s annual conference in Wellington in 2007. He has been a member of the editorial boards of a number of international journals including World Development 1992-97, Environment and Development Economics 1996-2006, and Asia Pacific Viewpoint since 1976. He is a regular commentator on energy, climate change and small-island states.