Citation: Sharon Beder, 'Power Failure', New Zealand Listener 190(3309), October 11-17 2003, 22-24.

This is a final version submitted for publication. Minor editorial changes may have subsequently been made.

Sharon Beder's Other Publications

The author of a critical new study of global electricity deregulation explains the dangers for New Zealand in letting market forces rule.

Since the 1980s, dozens of governments around the world have embarked on the road to restructuring, deregulating and privatising electricity systems. As a result, there have been worldwide blackouts, price manipulations, bankruptcies and electricity shortages. New Zealand has not been immune to these consequences, as the Auckland blackout of 1998 and the recent electricity shortages have shown.

Electricity "liberalisation", as these changes in the industry are referred to, has been driven by ideology and vested interests. Ideologues argued that electricity was a business and that as such it should be left to the private sector. Private electricity companies saw an opportunity to make money from electricity sectors in various parts of the world. Large industrial electricity consumers saw an opportunity to use their market power to get cheaper prices for electricity in the new markets. In addition, management consultants have earned large sums of money for their advice and studies on how to restructure and privatise electricity sectors. The public was routinely promised that liberalising electricity would foster competition and this in turn would improve efficiency and service, innovation and lower prices. Politicians were promised that privatisation would increase government revenue and that, in an open electricity market, investment capital for electricity infrastructure would be provided by private investors. Few of these promises were fulfilled.

Instead, liberalisation has seen the goal of a reliable, affordable, universal electricity service replaced by the goals of efficiency, competition and "consumer choice". Even where electricity companies have remained government-owned, as some have in New Zealand, they have been turned into commercial organisations oriented towards maximising returns rather than providing an essential service in the public interest.

Before restructuring, electricity prices were based on the cost of production. In the 1980s, however, production costs were perceived to be inflated by overcapacity and excess employment. The introduction of commercial goals and competition succeeded in reducing that overcapacity and cutting employment so that production costs fell. However, at the same time, prices were uncoupled from the cost of production so that lower production costs no longer implied lower electricity prices. In an electricity market, prices are based on supply and demand rather than the cost of production. This means efficiency gains are not automatically passed onto consumers.

Private companies usually turn efficiency gains into company profits, share dividends and executive salary rises, particularly when supply is short and there is little need to compete on the basis of price. The new electricity companies also have higher costs than the former government electricity authorities. These include higher interest rates, marketing and public-relations costs – used to attract customers and promote more usage of electricity and lobbying costs – necessary to ensure that government regulation is kept to a minimum.

Both private and government-owned companies in a competitive market use efficiency gains to offer cheaper prices to attract the larger industrial customers. As a result, although prices to industry may fall in good years, ordinary householders rarely see lower electricity prices flowing from the introduction of electricity markets. In New Zealand, prices to households have been rising since the mid-1980s, when the Electricity Corporation (ECNZ) was set up to operate on a commercial basis.

So-called efficiency gains come at a price to all consumers because they are often made through cuts to safety, maintenance, training and research budgets. Goals such as reliability, accessibility and energy efficiency all increase short-term costs. In practice, old equipment is not regularly serviced or replaced in advance of likely failure. Dramatic cuts in the workforce result in cuts to maintenance crews and accidents, and equipment-related blackouts increase. The reliability of the electricity supply also suffers from cuts to reserve capacity, which can lead to shortages of electricity during extreme weather conditions, as was experienced during recent droughts in this country.

Upgrading of network infrastructure also tends to be neglected and blackouts related to network congestion increase because planning and responsibility for network maintenance and development are not commercial priorities. As a result, blackouts become more frequent and are often more dramatic, as was seen most recently in the north-eastern US and Canada. These blackouts should serve as a warning in New Zealand, where network infrastructure that was installed in the 1960s and 70s will soon be due for replacement.

Planning and long-term forecasting of demand, as well as the upgrading of worn-out infrastructure, used to be an essential part of providing a reliable public electricity service. The need for long-term planning and co-ordination, and the unwillingness of private companies to take on the risks associated with constructing capital-intensive electricity infrastructure, were major reasons why governments took control of electricity in countries such as New Zealand in the first place.

IT IS TRUE THAT WHEN government authorities were in charge of planning, there was a tendency to overestimate future demand because of the political consequences that followed from failing to provide a reliable electricity supply and neglecting to encourage energy conservation and efficiency measures. But the costs of temporary oversupply were spread over a large number of consumers over long periods of time. Economies of scale combined with technological advances also ensured declining electricity prices, despite the maintenance of reserve capacity and timely upgrades of the networks.

In the 1980s, the need for planning and maintenance began to take second place to the desire to commercialise public services and reduce employment. In the 90s, when the pace of electricity liberalisation picked up momentum around the world, the planning function of government bureau-cracies was often abandoned altogether and surrendered to market forces.

Market forces are supposed to ensure there are enough supplies because the market is assumed to have the ability to balance supply and demand through competition. In practice, the market has turned out to be a rather poor mechanism for ensuring adequate supply. Electricity markets provide no incentive for generators to invest in new capacity – or, even better, to encourage electricity conservation and efficiency – because undersupply keeps pool prices very high and the standby plant necessary to ensure system reliability erodes profits. System reliability is compromised by the unwillingness of commercially oriented companies to maintain reserve capacity in case of sudden rises in demand.

In Australia and the US, companies have even artificially created the features of a shortage by withholding generating capacity in times of high demand so as to be able to charge very high prices for their remaining electricity. In New Zealand, according to consultant Bryan Leyland, when wholesale prices peaked earlier this year because of a supposed lack of electricity supply, some 400MW of thermal generation was not being used and the New Plymouth and Huntly stations were operating below maximum capacity.

Wherever electricity markets have been introduced, wholesale electricity prices have been extremely volatile, spiking at hundreds of times the cost of production if they are not capped by government regulation. It is not easy for the average consumer to respond to these price spikes by reducing their consumption when the price goes up. This is first because the average householder doesn't know when the wholesale price is soaring. Second, electricity retailers generally charge householders according to their total consumption, whenever it occurs.

And although it is true that many consumers use electricity too wastefully, the abandoning of responsibility and planning to market forces can only exacerbate the problem. Private companies are not likely to encourage energy efficiency when their profits depend on maximising demand.

The theory of the market assumes that supply and demand reaches an equilibrium at a price that is mutually acceptable to buyers and sellers. But because demand is not very flexible in the case of electricity, sellers have power over buyers, knowing that they will have to buy even if the price becomes unreasonable. They can exercise that power by charging exorbitant prices.

The experience of the electricity markets in Australia and New Zealand has been that private and state-owned electricity companies have made large profits by charging outrageous prices when demand is high and reserve capacity is low. This is why the wholesale price for electricity rose so dramatically here last winter, when lake levels were low, despite the existence of competition.

Large industrial users were particularly hard hit by high electricity-market prices and some large firms had to shut down or cut back on production. Businesses in New Zealand have long had the comparative advantage over international competitors of cheap electricity, but the market has changed all that. Companies now fear that the volatility of prices on the electricity market, the long-term increase in electricity prices and the lack of reliability of supply make it difficult for them to operate, and that this combination of negative effects could deter foreign investment.

Electricity is not a commodity that can be governed by market forces. It is a service that is essential to human welfare and economic prosperity, and it needs to be controlled by those who place public interest ahead of commercial imperatives.