Flaw in the electricity market laid bare by preliminary ruling against Meridian
Wednesday, 1 July 2020
OPINION A preliminary ruling that Meridian Energy withheld hydro generation from its Waitaki hydro scheme to raise wholesale electricity prices deserves to spell the end of the company in its current form.
The Electricity Authority suspects Meridian's actions caused an $80 million increase in the cost of electricity available on the spot market in December.
While many electricity retailers hedge against spot market prices, the authority said consumers will have lost out.
'In the long run, if retailers expect there to be high spot prices during times of abundant hydro storage, then retail prices will increase for consumers,' it said.
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By spilling water that could have used for generation, Meridian is also believed to have caused thermal power stations to have fired up more often than they needed to in December, which may have resulted in thousands of tonnes of unnecessary carbon emissions.
There could have been a knock-on effect beyond December, the authority's report also suggests.
By constraining the supply of hydro power to the North Island, Meridian worked against efforts to conserve North Island lake levels to cope with a scheduled March outage of the HVDC power lines that carry power under the Cook Strait, it said.
'North Island generation was dispatched instead of the fuel being conserved so it was available for use during the HVDC outage.'
Reaction from Meridian to these very troubling accusations has been limp rather than indignant.
About all it has said so far in response is that it will review the preliminary ruling and make a submission to the Electricity Authority as part of its consultation process.
To be fair, its chief executive Neal Barclay is currently not available to respond.
But the only quibble it has raised to date appears to be over 'misinformation' in some reporting on the ruling that the $80m impact the authority estimated would have been a direct one on consumers.
Condemnation from politicians has been swift.
Climate Change Minister James Shaw expressed 'disappointment' that Meridian's action might have led to 6000 tonnes of unnecessary carbon emissions.
NZ First primary industries spokesman Mark Patterson said that if the authority's decision was upheld 'heads should roll' at Meridian, describing it as a 'national disgrace'.
If it is lucky, Meridian will face financial penalties that could conceivably run to hundreds of millions of dollars.
Luke Blincoe, chief executive of Electric Kiwi, says a penalty of about $240m would be justified, based on the type of sanctions applied by the Commerce Commission for breaches of the Commerce Act.
The penalty would need to be in that realm to change market behaviour, he said.
But he believes that another outcome may that the matter results in the break up of the partly stated-owned generators, Meridian, Mercury and Genesis, into separate generating and retail businesses, in the same way and for the same reasons that Telecom was split into Chorus and Spark.
That is a change that would probably cost investors in electricity companies – including the Government – billions in lost profits, but which would hugely benefit competition, consumers and the environment.
Counter-intuitively, the need for such a structural separation of the 'gentailers' will only be reinforced if the Electricity Authority decides it made a mistake in its ruling and clears Meridian in its final decision.
Blincoe said, in that scenario, confidence in the current market would 'reach a new low'.
The flaw baked into the electricity market by former National Party minister Max Bradford when he designed the current market model in 1998 is a little tricky to explain but vital to understand.
It can be in the interests of large gentailers such as Meridian to underutilise renewable electricity and ensure the last megawatt of power needed balance demand and supply is produced using coal or gas.
That perverse incentive stems from the fact that the big gentailers supply most of the power they generate to their own retail customers, but at a price that is effectively controlled by competition from independent retailers.
Those independent retailers buy their electricity from the excess power that the gentailers sell to them on the wholesale market, so the incentive on gentailers is to keep the wholesale price high.
One way to do that is to spill hydro lakes and schedule power station maintenance in such a way that the very last megawatt needed to match supply and demand in the wholesale market is generated by power stations which are cheap to build but expensive to run – in other words ones that burn fossil fuels.
There is no need to take my word for that.
The fact the Electricity Authority has just spent six months investigating just such an allegation shows that the incentive exists.
As I've argued previously, a market in which all New Zealand's power came from renewable electricity plants – which are expensive to build but cheap to run, the opposite of thermal plants – would be a disaster for generators under the current market model, incidentally.
They would find it hard to avoid bidding the spot price of electricity down through the floor, even to a price below that needed to fund the construction of future power plants.
Currently, we have the opposite problem with gentailers' massive 'producer surplus' evident in their bumper profits.
But hang on, some might say, doesn't the fact that the Electricity Authority's preliminary ruling found against Meridian show that regulation works and that the market can be policed?
Unfortunately not.
Complaints about market manipulation have been made before, but as Flick Energy chief executive Steve O'Connor noted, they are very hard to prove.
The authority's current investigation stems from a complaint filed by seven independent electricity retailers who believed that they had finally caught generators red-handed in December.
Water was spilling out of South Island dams during a time of heavy rain and flooding while the wholesale price of electricity remained stubbornly high.
As O'Connor put it, 'we have watched and waited for an extreme moment where it is really clear what the behaviour is'.
Yet even so, it is clear from the Electricity Authority's preliminary ruling that the technical challenges it faced in reaching its preliminary conclusion were enormous.
To take just one example, the authority had to consider whether Contact Energy was justified in sometimes quoting higher prices than might have been expected during times of high water intakes for electricity generated by its Clutha hydro scheme, before it cleared Contact of wrongdoing.
That necessitated working out whether Contact's pricing could be legitimately explained by its desire to reduce 'wear and tear' on some newly automated gates controlling spill on the Clyde river and its need to periodically stop generation to clear flood debris from the grates protecting the turbines at its Roxburgh power station.
NZ First's Mark Patterson wondered how it could have taken the Electricity Authority more than six months to get to its draft decision.
After reading the 150-page report, I'm frankly impressed it finished it at all.
The authority noted it had to carry out two rounds of fact checking with Meridian 'because of the complexity of the material involved'.
Even then, it took the precaution of having its findings peer reviewed by economist John Small.
The 'gotcha' moment for the authority appears to have been not in the data, but in a perhaps lucky find in a December 16 internal Meridian report that made reference to a strategy of 'maximising sustainable generation while maintaining HVDC limits'.
The authority said 'managing the HVDC in this way benefits all South Island generators by preventing spot price separation between the North and South Islands' – in other words, it avoids flooding the South Island with cheap electricity.
The next step for the authority is to go through nine weeks of submissions and cross-submissions.
If after the extensive investigation it has already done, it was then to conclude that it had got it all wrong and Meridian had acted legitimately, how could anyone have any confidence in its ability to police the market?
The problem is that there may be just too many ways that generators could withhold generation and manipulate the market in ways that might seem like grey areas.
That's why the best result for Meridian may be that it is found to have misbehaved and is forced to stump up a couple of hundred million dollars to reset December's electricity prices and in fines.
The public and politicians might assume that regulation had won and it was a case of an expensive 'lesson learned'.
But that might be naive.
Really, as soon as the Electricity Authority levelled the accusation that the country's largest power company – one worth $12b on the NZX and 51 per cent-owned by the Government – had fallen for the temptation of manipulating a market that is so hard police, it needs to be game over for that market.
Guilty or not, when regulation gets this tortuous and tricky to police, it is the wrong regulation.