Friday 19 April 2013

An Open Letter to David Shearer and David Parker

Dear David and David,

I have read with interest the policy document you released yesterday: New Zealand Power, Energising New Zealand. I wonder if you could clarify a few points for me.

  1. In the document and the associated speeches, you quote the Wolak report's figure of $4.3b of, in your words, "super profits". Have either of your read the report, or any of the trenchant criticisms of that report? (A bit egotistically, I can suggest work that I was involved in, here, here, and here, but there are others.) 
  2. You say that "prices are rising faster than in many of our major competitor countries", and show a graph comparing the price trend in a number of countries since 1986. Let's leave aside the question of what is meant by "competitor country". Is it your position that prices were correct in New Zealand in 1986? Elsewhere you say that your new agency, New Zealand Power, will set prices based on operating costs and a fair return on capital. Is it your position that prices were generating a fair return on capital in 1986?
  3. You say that the faster rate of price growth in New Zealand "undermines the competitiveness of our economy". But one of your graphs shows that real industrial prices have remained about constant since 1986 and commercial prices have fallen. What exactly do you mean by "competitiveness"? 
  4. Your graph shows that the faster increase of prices relative to other countries has been fairly steady since 1986 albeit with an acceleration around 2000. Since your explanation for this price trend is a lack of competition in the market and the use of marginal-cost rather than average-cost pricing, is it your position that these factors have been changing steadily over the past 25 years, accelerating during the period of the last Labour government? Is it possible that the trend might be attributable to steady increases in demand over time and regulatory obstacles to power companies building new capacity? 
  5. You say that selling assets will "push up power prices even more as foreign and corporate investors look to maximise profits". Is it your position that the state-owned electricity companies are not currently looking to maximise profit, even though that is their fiduciary duty under the State-Owned Enterprises Act? 
  6. You state that the Wolak report found that the four big generators made "super profits of $4.3b at the expense of consumers". You also state that hydro generators earn "super profits" by using free water to generate electricity that is sold at the same price as generators using more expensive methods. Do you think this is what Wolak meant when he calculated the excess profits earned? Have you read the Wolak report? 
  7. As I noted earlier, you state that price will be set based on operating costs and a fair return to capital. But the Wolak report assumed that there was excess capacity in New Zealand so that a competitive market would have produced prices based only on operating costs. Are you stating that Wolak's $4.3b figure is overstated? Have you read the Wolak report? 
  8.  Drawing on a report you have commissioned from BERL, you state that your policy will create 5,000 jobs and boost the economy by $450 million per annum. In their report, BERL state that they are assuming an economy with deficient demand so that unemployed resources are avaialbe to the industrial and commercial sector with no opportunity cost. In citing that figure as an on-going per annum benefit, are you stating that it is your view that the economy will remain in a state of deficient aggregate demand forever, and that your government would take no other action to increase demand? 
  9. And if you have time, could you ask BERL whether it is not an oxymorn to have a computable general equilibrium model, and then state that "the model's calculation of the impacts on the government accounts exclude the direct loss of revenue from lower generator dividends and lower tax receipts from the generator's reduced profits". 
  10. By the way, did you know that one of the implicit assumptions Wolak used in his report implied that there was no efficiency loss from the putative overcharging, just a transfer from users to taxpayers? If you accept this report, wouldn't it be easier just to use the tax and benefit system to transfer money back to poorer consumers? Have you read the Wolak report?
Kindest Regards....


  1. I had been really hoping that you would have something to say on this topic, so thanks for delivering. But am still hoping for more - asking a bunch of questions is one thing, saying what you think is another. So what do you really think? Should add that electricity/energy pricing is something I am really interested in - one reason why we built a super energy-efficient house. Got a power bill today from Meridian - its five pages long to justify a power bill of $22.66! I do think there is something whackey about the energy sector in NZ becasue they get away with things they would not get away with in a more competitive market - such as charging me to send me a bill!

  2. VMC. Yes, this was a negative post, and I hope to find time to do a more serious analysis, but the next few weeks are insanely busy for me. My bottom line is that our biggest problem in NZ is geography. Second to that is the trade-off between environmental amenities and power is probably tilted too far towards the former in our regulatory framework. And finally, that fixed-price contracts for consumers means that we don't face the true cost of our consumption in times of peak demand. Nowhere on my list is the problem that the four large generators are manipulating the market to make the same four companies pay too much when buying from themselves on the wholesale market.

  3. Thanks Seamus, look forward to your fuller comments when you get time.

  4. Dear Mr Eric ,.. Thank you for your suggestive comments on
    power prices, I have not actually read the Wolak report in its entirety and in fact I have not read any part of it. ..
    However, as you may guess I have advisors , who repeat our fanciful imagination.
    That is why we have advisors Mr Eric because you chaps get very complicated.
    For instance Mr Matt Nolan reduces everything to a consequential equation which nobody understands. ,,, .. It s not that I am too lazy to read the report,
    I am not , I read the reports of my advisors,

    We are not concerned with the facts Mr. Eric.. ,, , we are are concerned with public opinion, and if that is not what you want well you should burn coal in your fireplace
    like that bloody Peter Quixote, and save power bills.

    We are in the business of nationalizing New Zealand. We are going to print money, and give it to other people, we are going to devalue the NZ dollar to 0.80 against the Canadian dollar , and I am going to be overthrown by Winston Peters within
    three months of Government.
    Why are you not happy with our program.

    Sincerely, David Shearer

  5. sorry Mr Eric, David Sherare here again, I suddenly realised that to devalue to 80 cents Canadian would be trivial. I mean 70 cents Canadian. Winston said.

  6. hi Seamus. It seems to me that the policy relies primarily on the transfer of Ricardian rents whereas Wolak was looking for evidence of market power. Even if there was zero (wholesale) market power, there is still a bid wedge of Ricardian rent in this market. It looks to me as if the Wolak debate is a sideshow here, albeit one provoked by the policy document itself.

  7. VMC, interested in your energy efficient home. I have aspirations to do the same (starting planning) and it seems like there are plenty of things that get in your way in this part of the world. But $22.66 implies that you succeeded - that or it's based on net metering and you have a big PV array.

  8. Hi Paul - which part of the country are you in? We have a little PV array on our roof but my advice to anyone who asks would be not to go the PV way unless you are totally mortgage free. We built our house for the average per sq metre cost. Its a passive solar design so it: faces north, has more insulation than the norm (With thicker walls and ceiling space) glass on the north (but hardly anywhere else) and a lot of thermal mass (stuff that warms up slowly and cools down slowly) concrete floors on the north side of the house and some internal concrete block walls. In my view basic design rather than technology is the way to go. Warm regards. PS we live in the Wairarapa where overheating in summer is as big a problem as being cold in winter.

  9. John. Good to see you back in the blogsphere. The Wolak debate is certainly a sideshow, and you may be right about the policy being mostly about transferring Ricardian rents, although it is hard to infer anything coherent from the policy document. But let's say you are right and that the main objective is to transfer Ricardian rents. But when MC is increasing as sharply as it is in the electricity market, the only way of eliminating the rents with a single price is through a massive departure from MC pricing. And the benefits of the transfer will be in proportion to electricity consumption. Now I don't know for sure, but I would suspect that consumer electricity consumption increases more than proportionately with income. So another way of stating the policy is that they want to incur a massive efficiency cost in order to effect a social transfer from poor to rich.

  10. "Now I don't know for sure, but I would suspect that consumer electricity consumption increases more than proportionately with income." - I'm not convinced that this is a good guess. A quick search comes up with an income elasticity of demand of 0.23 and a price elasticity of demand of -0.20 (based on US data). That sort of indicates that electricity demand is not very responsive to changes in income... Of course that doesn't tell the whole story in a NZ context. Our housing market is supply-constrained and quite expensive. Those on lower incomes are typically stuck in some quite old houses. These houses typically lack decent insulation, efficient hot water systems or any kind of non-electric heating systems (wood/coal fires only heat one room if they are installed). This makes for large expenditures on electricity. Meanwhile those in more recent (and more expensive) houses can take advantage of good insulation, gas-fired or solar hot water and gas/diesel/wood-pellet/coal-fired central heating (these alternative energy sources obviously have costs attached but are still much cheaper than electricity). This results in much lower electricity bills (see VMCs' post below for an extreme end of the scale)... It'd be interesting to get some actual statistics on this though, preferably from NZ. Anecdotes are no good for analytical purposes.

  11. Jack, you are right about insulation being highly correlated with income, but my sense was that low income consumers were much more likely to rely on open fires. Also, sheer size of house is a big determinant of electricity demand. But I would have thought the same was true in the U.S. as well, and so am surprised that the income elasticity is as low as 0.23. I wonder if the calculation is time-series or cross section. My view, however, would be that the efficiency cost is so great, that it would be a lousy way to transfer income to poor people even if the income elasticity is low. More to the point, was the proposed policy based on a view about this at all?

  12. John, I think you have hugely underestimated the efficiency cost (including the cost of a lack of security of supply), but that might be beacuse I believe the current price is not too far removed from marginal cost. But in any event, I don't think you can really mean that you would take the $300/year in return for the efficiency cost. Either you are choosing to ignore the cost in taxes (or lost other benefits) from the government being the supplier from whom the transfer is being made. Or you are assuming that the policy is being funded as a takings of private property, and are happy to be a party to social transfers being funded by such takings rather than honestly and morally as a burden we are all asked to share. Would you really want to do that?

  13. From a student flatting perspective (comparable to low-income housing), most of our electricity goes to hot-water heating. In the winter usage rises a bit with the use of electric heaters... 0.23 does seem quite low. That study uses time-series but I found older studies that got similar numbers using cross-sectional data... As for the politics of it, my guess is that it's some kind of gimmick. While it might not be a very efficient scheme, cheaper power certainly sounds good on paper... Building new capacity is probably a better way of achieving this though. Surely if there are heaps of 'super profits' being made then it's only barriers to entry keeping other players out of the market (and a little uncertainty about where government energy policy will go next).

  14. What I mean is that voters are being offered $300/year but there is an efficiency cost. It'd be nice to know the relative sizes of these things. Using some rough numbers I agree that my 1:20 guess is wrong and the truth could be more like 1:5.

    Not sure where you're going with the morality angle, but let me just say that to the extent this comes from SOE's it would basically be a tax cut and I have no moral objection to tax cuts. Its not nice for Contact and Trustpower investors, but they must have known that regulation is very very common in this industry. Provided voters are well informed, is there any reason they should not have a choice between this policy and the status quo?

  15. If it's a tax cut, surely it's one of the worst ways of doing it. Reduce the abatement rate for WFF if you want something that'll cut taxes while getting efficiency gains rather than efficiency costs.