Tuesday 28 July 2009

Electricity Report: Who Paid the $4.3b?

The slides from my talk at the Institute for the Study of Competition and Regulation (ISCR) on the Wolak report into the electricity industry are now posted on ISCR’s website.
This is the study that produced newspaper reports like the following:

Power companies face public outrage after a Commerce Commission report said they had overcharged customers $4.3 billion.

I will blog a bit over the next few days on why I think the $4.3b is heavily overstated, but first it would be useful to correct a misunderstanding in the way that the study has been reported in the press.

In New Zealand, wholesale electricity prices are determined every 30 minutes in an auction market in which electricity generators submit offers for how much electricity they would be willing to supply at different prices at different injection points on the national grid, while buyers submit bids to buy electricity at the exit points on the grid. The computer-based market maker then sets the prices to equate supply and demand taking into account energy loss along the transmission network. In principle, generators can submit offer curves that are higher than their true willingness to supply (essentially pretend to be willing to supply less than they actually would like to) in order to push up the price. In the retail market, electricity retailers buy electricity from this wholesale market to sell to final consumers, usually at a price that is fixed for 12 months or more.

The Wolak study looks at the wholesale market, not the retail market. The $4.3b is an estimate of how much electricity generators have overcharged wholesale buyers. But who are those buyers. A small percentage are large industrial final users who purchase directly from the wholesale market at spot prices. But the overwhelming majority of purchases are by retail companies, who are mostly also the big generators. That is, the unfortunate purchasers that Wolak estimates have been overcharged $4.3b by the four large generator companies—Meridian, Genesis, Mighty River Power, and Contact—are, in fact, none other than Meridian, Genesis, Mighty River Power, and Contact!

A full study of the retail industry might reveal that there is pass through from wholesale overcharging to retail prices, but such a study has not been conducted, and it is by no means clear theoretically that such pass through would be profit maximising behaviour in a vertically integrated industry.


  1. I'm reading your slides on ISCR. It looks like it would have been a great presentation. Without the content of the discussion, your slides provide a brief, skimpy, but tantalising look into your argument. Are you writing it up or putting out a discussion paper or something?


  2. James,

    I am hoping to put out a working paper with a detailed critque on the Wolak report. Given other commitments, however, it might be a few months away.

  3. No worries, I look forward to it :)

    James Hogan

    ps(You're not from the Westend Tiddlesworth side of the Hogan family are you? I think I shall call you James II ... ;) )