Member log in

It’s the market, stupid: that’s how power works

HIDESIGHT

I keep being told that the market for electricity has failed us. It could be that I am stupid. Or ideologically blinkered. Uneducated. In the pocket of Big Business. Lack empathy for the poor. Or all of the above.  

But I seriously don’t know what it means that the market for electricity has failed. I turn the switch on at home and I have electricity. All that I want. Two weeks ago a young man knocked on my door with a better deal from a rival retailer.  

He walked me through the numbers and signed me up. I switched retailers and I am now saving significant money. How cool is that?

Labour has fired a blunderbuss of reasons why the market is not working. The first is that electricity prices have risen faster than inflation! I feel embarrassed even typing that.

Individual prices aren’t supposed to align with inflation. They are supposed to match quantity demanded with quantity supplied. That’s how a market works.

It’s absurd to be bashing the market for doing its job of matching supply and demand, and of providing the incentive both to conserve power and invest in generating capacity.

Labour complains that electricity prices aren’t “fair”. But a fair price in a market is one on which willing buyers and willing sellers agree. And that’s precisely what happens.

The third failure is that generators are making “super profits”. That’s because some generators are cheaper to run than others and it’s the more expensive generators that set the price. Once again, that’s exactly how a market works. That’s if the supply curve slopes up – which at any moment in time it certainly does for electricity.

We have land that is more productive and fertile than other land. That land is worth more. Once again, that’s the way a market works. Hydro is more “productive and fertile” than thermal generators and the dams are worth more, just as better land is worth more.

One of the easiest
Besides, the electricity market is one of the easiest markets to enter. The system operators are eager to hook up new generating capacity. All you need is a generator and a connection.

The big hurdle is the Resource Management Act, which makes developments tough. But that’s not a failure of the market. That’s a failure of successive governments.

There’s nothing stopping Russel Norman, David Shearer and David Parker building their own generator, proving there are super profits to be made, driving down prices and funding their own election campaign in the process.

Of course, they won’t because they can’t. Their rhetoric is not the reality.

Labour’s analysis makes a further serious mistake. It confuses price and cost. The government can regulate power prices downward. But that doesn’t change the cost of suppling electricity.

Indeed, the increased risk that government is putting on the generators will increase the cost of electricity.

The nannas at BERL run their computer model to conclude that Labour’s policy will generate jobs and wealth. It won’t. BERL confuses cost and price.

Of course, getting the cost of power down would boost jobs and incomes. But regulating the price down won’t. All that will achieve is rolling blackouts, business collapse and serious under-investment in generating capacity.

I am long used to politicians and BERL failing school-level economics. But it’s the endless repetition of the nonsense by journalists and commentators that’s embarrassing. They are paid to know better.

More by Rodney Hide

Comments and questions
73

We are dealing with Green / Labour here, common sense, infrastructure sustainability and economic reality don't even come in to the picture. I find it ironic that when they were in power last time they wanted to price of power to increase and brought in the ETS to do it.

Pollution is an externality and must be factored into the cost of using fossil fuels. That is the only way clean energy alternatives will become cost effective. An ETS is a method of achieving that. If massive industry cashes in on not having to pay for the damage the use of its product creates (as has been the case for generations) then a people's Government must intervene. (eg, tobacco)

Distorting oligopolies such as in the electricity market have a market distorting effect as well. Yes, we can buy electricity within a range of prices. That range is truncated by a low price elasticity of demand and, probably, collusion. But I want to buy electricity that is generated with a very low footprint on the environment. Uncosted externalites artificially make oligopolist generators more cost effective than other cleaner, lower impact options.

Uncosted externalities distort the market, therefore the people's Government must intervene with taxes or subsidies. Simple.

The problem with the ETS is that the price of emissions is not linked to the actual cost to society so the true cost, which may be higher or lower, has not been internalized. That makes it hard to sell the benefits of the scheme, especially when the costs borne domestically by domestic emissions are likely miniscule.

In fact the "externality" of CO2 production is probably in favour of the polluter, since it makes plants grow better, grows more food and fewer people die of heat than of cold. Simple?

This comment is too stupid to address other than noting its stupidity.

The international carbon markets have already quantified the stupidity of your contrary position by collapsing. Global warming has failed to follow the equations predicted for the growth of CO2 levels but plant growth has been enhanced as predicted. The cost/benefits claimed by the Stern report were always fraudulent and remain so - which is why Kyoto has been abandoned by every country that matters.

But "pollution....as a cost of using fossil fuels" doesn't apply to MRP which is mainly hydro. In NZ, electricity generation (as opposed to other fossil fuel usages) is mainly hydro with some gas, and therefore the ETS is largely independent of these costs.

Rivers and landscapes have been destroyed for hydro and wind projects - I assume this isn't the "electricity that is generated with a very low footprint on the environment" that you want? Thank heavens a rational approach prevailed at Meridian recently and the destruction of the Mokihinui was prevented.

To add insult to injury many of the projects built by the "Peoples Government" in the past were highly subsidized by the taxpayer. Clyde was supposed to cost $400M and ended up at over $2,000M and there are plenty more examples.

Excellent article Rodney.

People don't seem to realise that there is only enough water stored behind the dams for around 30 days of electricity production, hence why the price of power is more directly aligned the price of generation from coal and natural gas - they are in place almost as a back up.

As we don't currently have much of a method of storing water long term, this isn't likely to change soon.

Rodney, thank you again for another easy to understand excellent article.
My provider gives a 22% discount if you pay on time via the internet. If you turn the hot water off when away from home or even through the day there is a saving.
Their personal phone service is respectful, pleasant and offers alternative costing solutions for your individual case. They respond quickly to competitive services.
Labour should concentrate on competition for ACC and an end to the Maori payouts. Thats real super profits.

Rodney, that article should be drummed into every supporter of the Labour/Green proposal, and anyone who believes free lunches are there for the taking. Also it should be drummed into every school kid who is learning basic economics, and every voter who thinks their electricity bill could be lowered without the govt. having to raise the missing 700 million from some other tax because they will not even consider reducing expenditure . No point in trying to convince Shearer. I'm sure most of the Labour MPs understand this, but they also know how to play populist politics. The Greens are different; they have their own beliefs and ideals on how to control everything about the planet, and we certainly know Labour's suggestion that this will help industry expand will have them weeping into their organic carrot juice.

The article is just plain wrong. Based on last century fallacious economic theory full of simplistic assumptions, you know the guns and butter stuff and theory of perfect competition. All discarded and disproven by 21st century economic research using real data and mathematical modelling and human decision research. You really need to get yourself up to date.

Maybe you could explain some of that "economic research". Has this research actually been tried in practice? Does it involve doing what the failing economys are doing such as printing money?

So does vastly succesful NZ know something the failing, money-printing economies of the USA, Japan and Great Britain don't?

Actually, if you look at growth rates, unemployment and other key indicators, you are right - NZ is more successful and those economies you mention are failing - hence their need to print money, and our common sense approach not to.

Unfortunately politically, you could compare the Greens to teenagers - they know everything and their parents are dumb. They have not yet come to terms with themselves and their limitations. They are a party of ideas. Untested ideas, and a lack of understanding of the marketplace, and an absence of defining or aligning principles.

Very kind. Thank you. It's hard to see what's not working about the electricity market. And it is very ironic that for years both Labour and the Greens have been telling us power is too cheap and have been implementing policies like the ETS and the ban on mining coal to make it more expensive.

Hydro isn't cheap. It's real cost is its opportunity cost and that clearly is high.

Still, the policy is about politics, not economics. But I believe as long as they use economics badly to bolster their politics we are permitted to skewer them on their argument.

Love the missing money myth lol. The price reductions end up in every business and individuals bank account to be spent on goods and service perhaps capital equipment some may be saved. BERL economics estimated the creation of NZ Power would increase GDP by $450 million while creating 5000 jobs. That means tax income to the government. Makes Nationals claim to being business savvy look to be nothing but business puffery and self delusion.

BERL didn't estimate anything. They ran their model that pretends to be the economy and then pretended that electricity prices were suddenly cheaper AND THAT NOTHING ELSE CHANGED. Trouble is, we know that quantity demanded will shoot up (it's cheaper), quantity supplied will fall (returns are less), there will be blackouts, and their will be business failure because they don't have power. BERL didn't model that!

Rodney, your economics is old world and proven wrong. You are using simplistic individual demand theory which doesn't scale to the macro, and current decision research doesn't support the assumption that if power is cheaper people will buy more. With many NZ citizen financially stressed they are like to spend on food and clothing which are the things that people for go to keep the power on. Suggest you look a Prof Steve Keens research and read Daniel Kahneman's book "Thinking fast and slow" on human making decision characteristics which won the Nobel prize for Economics. Economic models, you know computerised economic forecasting are the norm.

"old world", "proven wrong" etc.

I think you will find supply curves mostly point up and demand curves mostly point down.

Marx could never accept it either. That's why he didn't finish Das Kapital. He left it to Engels who unlike Marx wasn't familiar with the work of Jevons, Menger and Walras.

I equally could suggest that you are peddling the old view.

But the proof is in the eating. Neo classical economics provides powerful explanatory and predictive power of human behaviour.

Computer models? Not so much.

Rodney, I totally agree that the proof is in the eating, and to that end I ask you did neo classical economics/economists predict the Global Financial Crisis? The answer to that is they didn't have a clue until it hit them between the eyes. However, a group of 21st century economists predicted the GFC as far back as 2005 and published papers on their work and publicised this worldwide. Their work not only predicted the GFC but has proven how flawed and misleading neo classical economics is. Of course, you are perfectly entitled to live in the past if you wish.

Rodney,

The computer models are based on the same macroeconomic principles you are talking about. In CGE, which BERL used, all the computer does is compute the equilibrium, which used to be done by hand but if a large number of markets are included (BERL used 50 odd I think) finding the equilibrium becomes near impossible.

CGE models each market with a supply and demand function, consumers have utility functions and firms maximize profits. Further, since it is a GE model the entire economy is included, rather than being left out (the reason for including so many industries) since there will be feedback effects. Those feedback effects make calculating the equilibrium mathematically near impossible but computers can use iterative methods.

The problem with the BERL report is not that it used CGE. The problem is that they have not released the documentation of the model because there are a huge number of assumptions that have to be made which will influence the results.

Your argument of using basic supply, demand to evaluate policy will miss secondary and feedback effects and is not good for identifying changes numerically, only directionally and even then is very rough.

A splendid example of how the ideological can be wrong in every detail. No, any price reductions will go to residential consumers, not businesses, according to the proponents. The consequences of unreliable supply due to under-investment will be borne by businesses. GDP will reduce because of the increased management bureaucracy and flight of investment due to perceived regulatory risk and loss of property rights.

The Labour-redGreen Government will not survive the economic collapse it provokes but the electorate will have the best part of a decade of misery to rue its folly.

The Left will claim the only failure was the failure to nationalise everything.

Business gets the more competitively priced power too. That makes NZ businesses more competitive. There maybe power over supply if the aluminium smelter goes belly up. Economic collapse - yeah right lol.

You certainly still believe in Santa Claus if you believe business will get cheaper power.

You must be too young to remember the Clark government U-turn in 2001 when it discovered it had seriously annoyed the business sector. That will be nothing to the backlash if this kind of idiocy is implemented.

Alan - you are replying to any of his arguments - you are simply abusing him.

I can't give any consideration to your argumments when there is only abuse - and that approach is putting me off.

Shona, the details are available everywhere if you are really interested but I presume you are not since you haven't bothered to inform yourself. Challenge any of my statements and I will produce the evidence.

Give me detail on any of your statements before you start throwing abuse around, for goodness sake.

Don't be pathetic, woman. I haven't abused anyone - unlike your mate, Paul N, who does nothing else. I'm not here to do your work for you. If you want to know something, get off your butt and find it out. If you think I'm wrong about anything do some homework and try to prove it.

OK that tells me everything - you really are just a grumpy old right wing ranter.

I'm not in the least grumpy, Shona, but you have contributed exactly nothing to the discussion and will doubtless vote based on that slothful ignorance for idiotic, damaging policies. You will then blame everyone else for the consequences.

Making stuff up again.

So why do Labour reject that theory when considering tax cuts?

Not sure what you mean. But one thing is certain and that is economic success and low tax rates show no correlation. At the height of both NZ and US economic success post WWII both country's had significantly higher rates of tax.

The price of electricity is not set purely by supply and demand. Just like the price of petrol is not either, or the fees bank charge customers.

With only a few suppliers of electricity, and barriers to switching supplier, suppliers are able to charge a premium above where demand and supply meet, which accounts in part for the large profits and high electrictiy costs.

How can there be barriers to switching suppliers when 342,000 households managed to switch last year? Or is the entire argument just a theoretical one?

Anonymous must be talking about a different country when he/she refers to barriers to switching. It is very easy to switch and access the cheapest supplier?

What barriers to switching suppliers? It's as easy as the click of a button! Comparing prices is equally as easy...

Imperfect knowledge of how to switch supplier.
Lack of price differentiation between suppliers to make it worth while switching.
Parts of the country there are only a couple of alternatives.

Do you really think the petrol companies set prices where demand and supply meet? Or like the electricity companies, they ALL price a good margin above where demand = supply (i.e. profit !)

This is where the role of government comes in; stopping anti competitive behaviour for the benefit of the consumer, while still alowing corporations to make good profits, but not collusion on price setting.

This is a very good example of a free market failure.

18 percent of households managed it last year.

Lack of price difference? If it there was a lack of choice and competition you would expect high price differentiation.

Besides, the intervention proposed is at the wholesale market.

Should petrol, too, have a government-owned single desk buyer? If not, how is it different?

Exactly. 18% is very small. Perhaps that represents all those who know how to, or who are able to switch to a viable alternative to make a saving. If anything it demonstrates there is no point in switching.

The crux of this matter is lack of competition, and I suspect because of that a collusion on pricing. The energy market is where the telco market was in the 1990s, with only a few players, meaning they can hold prices high under duopolly "like" conditions.

Until more players get in (like the new telco's today) it would be in the community's interest that the government regulates and monitors price setting.

18 percent is the second-highest switching rate in the world. But again, that's not where Labour is making any changes. Their changes are to the wholesale spot market.

The government does monitor and regulate prices. That's the job both of the Electricity Authority and the Commerce Commission.

The Labour and Green proposal is not to monitor and to regulate but to have a single government-owned buyer and the force the price down in the wholesale market from $2.1bn to $1.4bn which they pretend they can do without consequence other than on final retail prices.

The Commerce Commission needs a kick in the back side. It has been ineffective in brining any changes to anti competitive behaviour - the real source of the problem.

If you look at any financial or commodity market around the world, if participants aren't stringintly monitored (and prosecuted for breaches) then massive profits are able to be made from market manipulation. I would not bet against manipulation in the NZ electricity spot market, as happens in world wide equity, debt, fx and derivative markets. A good recent example being Barclays manipulating LIBOR. NZ has been plagued by farud recently - it is not exempt from such conduct.

18%... pathetic.

The fact you suggest 'collusion on pricing' shows you have absolutely no understanding of how the electricity market works in NZ.

Actually, under conditions of collusion with only a few players in the market prices will congregate, not differentiate. Look at the airline industry where recently collusion of the two or three main companies were busted by watchdogs. Same concept.

That in large part is the absurdity of your argument -- they are guilty whatever the pattern of price differentials!

No. I think the issue you is your understanding as to what drives price is too simplistic (a bit year 1 economics). Pricing differences can arise for a number of reasons, for instantce companies have different cost structures. BUT, prices can also congregate under conditions of market collusion, which is what I am suggesting is occuring because of lack of competition, and possible manipulation of electricity trading, as occurs in many other markets.

Rodney: One query, one comment please:
1. Why, when demand is lower, have prices not dropped? isn't that the very underlying principle of the market you're talking about and what is happening in energy markets elsewhere?
2. Be wary of the knock on door - most price differentials have turned out simply to be a difference in timing between companies of their price increases

1. I am afraid I am not sufficiently into the actual market to comment knowledgeably about day-to-day prices and the movements in supply and demand. There are plenty of reports prepared by the Electricity Authority and Ministry of Business, Innovation and Employment though.

2. Interesting. I will keep a watch on that. Thank you for the tip.

Rodney - but do you accept in principle that reduced demand should lead to a reduction in prices?

It's an elevator that goes up, but never comes down :-)

Look at the half hourly spot market data, any drop in demand leads to an immediate fall in the spot price.

John key has just asked the oil barons to lower their price fixing arrangement temporally so as to confuse people that Rodney’s simple supply and demand model is happening in practise – not just in his fifth form head!

I am pleased that you have highighted the absurdity of Rodney's simplistic understanding of price setting. Well done.

Right on Rodney. Commodities always react to price, so lowering price = a rise in consumption = more generation required = more capital investment to meet demand. The current model is designed to provide for increased demand. The Lab/Green proposal not only is not able to meet future demands through natural growth, but to compound that by encouraging demand. Put simply any lower prices will be temporary, or we will be back to the days of power cuts. There is no free lunch.

Well that's an interesting argument - keep up the excvessively high prices as an energy conservation measure! You must have too much money to be able to argue and afford that. Affordability is what is limiting demand at the moment - for both residential and business customers.

You haven't understood one word of the article outlining supply and demand. I certainly do not have too much money, but I do know how markets work. I know what happpens when they're prevented from working too. I'm not arguing for high prices as you suggest. I'm making an observation. If you think the prices are excessively high, do as Rodney suggests. Generate your own or go without. I very much doubt there would be a household in NZ who couldn't reduce consumption if they tried, so shop around, find a cheaper supplier or make your own. If that fails - turn something off. .

The petrol company analogy is appropriate.

Power companies are energy producers and therefore can control price by restricting supply into the market, pushing price up (amongst other ways of maintaining high prices).

It is a similar situation to why we have high prices at the petrol pump.

They can only control prices by restricting supply if all suppliers act in collusion. Are you telling us the Government SOEs are doing this?

Evidence to us and the Commerce Commission please.

Who decides when to make power? Who decides when to run the turbines and when to close them down? The power companies do.

Proof of collusion - you bet, difficult. High prices and high profits are the smoking gun in an oligopolly like commodity market.

Are the NZ regualtors and watchdogs smart enough to catch them or prove it? Not yet. lets hope they get smarter and keep investigating. Perserverance got the oil companies and airlines for price fixing...

"Who decides when to make power? Who decides when to run the turbines and when to close them down? The power companies do."

Yes, individually. So if one decides to withhold supply it makes money for all its competitors and forgoes it for itself. We are supposed to believe that both private and public generators are working together as a cartel? I don't believe it.

I suspect high prices are actually the smoking gun for barriers to competition and increased supply caused by Government ownership, the RMA, bans on coal-fired and nuclear generators and the ETS alongside monopoly transmission providers. Prove otherwise if you can.

Alan, I agree, the govt has the energy market stitched up. It is the remaining govt intervention in terms of preventing entry to the market that is keeping prices high.

Try putting a submersible hydro generator in the creek that runs through your property and you get a knock on the door and legal papers shoved in your face demanding you remove the equipment. Despite that the generator will not restrict flow or impact on the environment.

There is enough water flow in major rivers to increase power generation 10-fold, and you don't need big dams to do it. But the authorities don't like that which they can't control. You would get a lot of small local power companies being started and eating away at the inefficiency of large hydro schemes. You would actually have an excess of power and prices would fall.

You can get small Archimedes screw generators the size of a gym bag that can generate 5KW and the size of a 44-gallon drum will generate up to 30KW. Forget wind turbines, the energy is there for the taking and would make households less reliant on the large dams and the high prices, but Noooo, nanny state can't have that.

I agree with Rodney's article in full, but in some way the people moaning about high prices have a point. The part that Rodney missed in the supply and demand graph is that the supply is severely constricted by govt policy, and thus keeping competition down and prices up. Also the cost of maintaining the large dams and the millions of kilometres of transmission cables is massive. Imagine a world of more power, less cables and lower prices.

If everyone in the high country took power from the rivers, and irrigation channels, there would be no impact on the environment, and the huge cost of running and maintaining cables to country areas would be averted and costs would fall.

The power companies have had the designs for generators powered by waterfalls and small rivers for decades, and successfully influenced policies and regulations that prevented the use of these resources. The RMA is one of those instruments.

If the Greens actually lived up to their mantra of protection of the environment and of sustainability, they would not be crying for state control of the environmentally impacting dams, overhead lines and power companies; they would be campaigning for the right to use small environmentally friendly generators.

The Greens are about alternative power sources, so why invest effort in wanting to control the power companies when the answers lie elsewhere? The agenda of the Greens is not about alternatives and being friendly to the environment at all; it is about control of wealth.
Red with a Green coating to fool those members of the public who cannot or will not think for themselves. The Green with Envy Party.

Well detailed, Samuel, and correct. Unfortunately, environmentalism has fallen into the hands of technically incompetent, grotesquely unethical political ideologists.

Shadows of Mao and Pol Pot they will create humanitarian disasters through careless ignorance while proclaiming the highest motives. They will be served by bureaucracies happy to be ever-extending their powers over the populace.

Rodney, the problem with you. You talk too much common sense. Would you have said same if you were still in Parliament's liars den of iniquity. If so, get back into politics pronto.

Re "But a fair price in a market is one on which willing buyers and willing sellers agree. And that’s precisely what happens."

This is palpably rubbish, Rodney. And yes, it *is* simply part of an ideological mantra. As ever.

The home buyer is over a barrel, especially families with children and high power demands. There is very little real movement between the power companies where the difference in price is pretty small beer, in a low wage economy.

Moreover, you must know very well at the far Right's reform of electricity was over- complicated and saw prices shoot up rather than being lowered.

The reality is *not* your rhetoric...and the intelligent home-buyer would not agree with you.

The trouble is that blinkered far Right individuals give the free-market a bad name, by arguing its workings are perfect. They're not. The market is by no means largely rational - it can be equally irrational, gullible over-credulous, or panic-driven.

The proof of the pudding isn't in ideology and bluster...It's in seeing how things really work, by testing, independent analysis, and observation..

.Stop treating the market as if is is a god...it is a very imperfect system, as fallible as human beings themselves, and it cannot sustain the load of belief you place in its workings.

Spot on. The free market has many many failings. We are still feeling the effects of the GFC, a wonderful example of it. Short-term greed of traders hunting annual bonuses, selling CDOs (colateralised debt obligations) containing low-quality mortgages basically stuffed the world enconomy when the US housing market declined and no one could value the CDOs.

A very imperfect market phenomenom that was only brought under control by world wide government intervention - not leaving the market to self-implode as a pure free market ideologist like Rodney would advocate as the cure. Nuts...

I'm afraid leaving the market to self-implode when it's turning to custard is exactly what you do. It quickly wipes out bad decision making, waste and lending allowing the new entity to emerge.

If it doesn't emerge it was never needed in the first place.

So you think all the governments and central banks of the world were wrong in 2008 to take action to avoid a depression from the contagion effect of massive companies falling over? But you are correct... yeah, right...

Academic rubbish buddy. If the Wall Street banks weren't propped up, the financial markets may well have completely collapsed, and NZ as a massive borrower would not have been able to afford to fund its capital markets = massive depression.

Do you think the massive depression is avoided? It's just disguised by more and more debt. The correction is now long and drawn out. Capitalism is swift to reward the right decisions and swift to destroy bad decisions.Time will tell.
The rise in the Dow is just the equivalent of all the money printed.

What you are really saying is that when we have business collapse big or small we strip money off the positive and profitable enterprises to prop up failure.

I agree, Labour in love/green sausage ... should bring a new market player and change existing equilibrium. We are all utility maximisers and a new offer only can bring price down in a compact market. Dictating price at wholesale is a lazy way to educate people of NZ to save energy and alter consumption of households or poor habits...different social economics...always providing rather than saving. So, are they going to make poor people richer with a better priced, electricity bill? Not sure, it is like offering free milk in ice cream only...ready for electric BBQ? Sounds green for a change.