20 April 2002

An Editorial Review - The 1998/99 Electricity Reforms

(By Hon Max Bradford, Former Minister of Energy)

It has been nearly 3 years since the last major stage of the New Zealand reforms to introduce competition into the electricity market were implemented. As they have been elsewhere in the world, the last stage was perhaps the most controversial, so it is timely to review whether the objectives of the reforms have been delivered.

The Overall Reform Process

The process of introducing competition to the New Zealand electricity market began in 1986. They have been complex and often controversial, over the life of three governments and five Ministers of Energy.

The early stages of the reforms, in the early 1990s, were designed to introduce more effectiveness and efficiency into the electricity generation, transmission, distribution and retail supply sectors of the electricity industry. The full chronology and explanation is set out in the Electricity Reform Chronology document on this website.

The objectives of the last stage, implemented on 1 April 1999, were clear: to deliver choice (of electricity company) and lower electricity prices (both wholesale and retail) to consumers.

Proof of the promised results for consumers is now clearly available from official sources. Nevertheless, there was a very difficult period for some months for many people, as companies and consumers adjusted to the new competitive market in the months after 1 April 1999.

The National Government expected some difficulty as the major changes bedded down; but I think it would be fair to say that everyone, including me, was caught by surprise at the extent of the disruption for some parts of the country.

In part, this was because some companies did not support the reforms. Some in the industry suspect a few companies of unnecessarily complicating and delaying the customer switching processes. Consumers who wished to switch power companies were subjected to behaviour quite at odds with what you would expect from service-oriented, customer-focussed companies.

In addition, many power companies discovered that their back-office billing systems could not cope with the volume of switching which occurred, and some companies had difficulty in integrating different customer billing systems as the new structure of the industry bedded down.

In retrospect, I regret that we did not allow a longer period for the introduction of the major changes. We acted on the best advice on implementation at the time, which in hindsight proved to be wrong. For that I have to accept responsibility and I do so, unreservedly, as I have said publicly on a number of occasions.

We promised consumers choice and lower power prices. Well over 90 percent of New Zealanders are enjoying the promise. Very few areas of New Zealand have yet to get full choice and some people are paying more for their power for a variety of reasons. Only 2.8 per cent of New Zealand electricity consumers face a monopoly; over 60 per cent can choose from 5 or more companies in their area.

But National never promised 100 percent to 100 percent. Compared to the years before the reforms, most people - by far - are better off.

Our experience is at least as good as, if not better than, the benefits which have accrued to millions of electricity consumers in other countries where competitive electricity markets have been introduced.

More Choice of Electricity Supplier

With respect to choice, New Zealand has one of the highest switching rates of OECD countries which have introduced competition into their electricity markets. This is the clearest measure of consumers exercising choice, where they want to switch from one company to another to supply their electricity.

Over 755,000 New Zealander consumers have chosen to change their electricity supplier (some more than once) since the reforms became effective on 1 April 1999. Around 20-30,000 consumers switch electricity supplier each month even now, three years after the reforms took effect. The vast bulk of these people clearly have switched satisfactorily. Not everybody did in the few months after April 1999; but that is hardly surprising given the behaviour of some companies towards their customers when competition was first introduced. Thankfully, this behaviour is rare now and the industry has imposed penalties on itself for non-compliance with quite strict switching rules.

Lower Electricity Prices

On the price side, the charts and tables enclosed show that for a wide array of consumer categories, nominal prices have either fallen quite steeply or, in the case of households, the rate of increase has consistently flattened off for the first time ever. If we adjust for inflation, in every case electricity prices have fallen, in some cases quite steeply. In fact the picture is better than these statistics, as the rebates paid by many lines companies are not reflected in the prices measured by these official sources. Recently, prices have begun to rise again, but this is to be expected.

But for the Labour/Alliance/New Zealand First/ ACT blocking of the regulation of monopoly lines companies introduced into Parliament in July 1999, prices would have fallen even further, especially for households. Recent academic research has shown that consumers are paying something like $200 million more in lines charges than they should be.

We should not forget, either, that many communities around New Zealand have got a windfall benefit from the change to the structure of the industry. Local power companies were required to split into two companies; one which retailed electricity to customers, and the other into a local monopoly lines company.

Most chose to sell the retail customer base and take a healthy profit on the value of their local electricity consumers. The decision to sell was not a requirement of the reforms, but the choice taken by locally elected boards. It was possible for local power companies to split into two locally owned trusts; one for retail, one for lines, providing they were quite separate in management and governance control. This would have kept the power companies in local hands.

The result of these sales was that there is now something like $2 billion sitting in a variety of community trusts and local power company trusts around New Zealand, which are used either for rebating the profits of the lines companies, or for charitable purposes in their communities.

Often this has been to the disadvantage of electricity consumers in their regions. The price paid for customers by the retail electricity companies, and demanded by the locally elected boards was, in my view, excessive. This has helped contribute to the fact that household electricity prices have remained higher than they should be in some parts of New Zealand, even given the existence of the newly competitive markets. These were local, not central government decisions.

Sale of Assets

The National Government has sometimes been accused of selling locally owned power companies. This is utterly untrue.

Supply authorities (ESAs) or local government owned these companies. Therefore, central government was not in a position to sell them. Any decisions to sell were made by local body politicians or locally-elected ESA members.

The only electricity asset sold by central government was Contact Energy, which was floated to New Zealanders as well as to a cornerstone shareholder; and a small electricity company in the South Island, which was sold to the local community in the late 1990's.

All other state-owned assets that made up the old ECNZ (Transpower, Meridian Energy, Genesis Energy and the Mighty River Power Company) remain in government hands.

Is New Zealand the odd-man out in creating a Competitive Electricity Market?

The answer is no. We are mainstream.

You might be interested in the summary pages of this recent document published by the OECD , which has examined the comparative performance of electricity reform across the OECD countries.

There is nothing remarkable about the reform process we engaged in - a process, which has been under way over the last 15 years, long before I became Minister of Energy.

The stage we undertook in 1998-99 was the last substantial change necessary to achieve a fully competitive market, with one exception - the regulation of monopoly lines companies.

After stopping it in 1999, the Labour/Alliance Government is now dragging the chain on the regulatory process for monopoly lines companies, which we wanted to do in 1999. That has cost consumers about $200 million so far, as noted already.

Perhaps this quote from the OECD document might put our reforms into context: -

"Virtually all OECD countries have decided to open up their electricity markets, at least to their big industrial users. In many countries electricity markets will be open to all users, including households. This is already the case in Finland, Germany, New Zealand, Norway, Sweden, England and Wales in the UK, and several states in the US and Australia.

By the year 2006, more than 500 million people (and all large industrial users) in the OECD area will be entitled to choose their electricity supplier. This accounts for nearly 50% of the population of OECD countries."

The conclusion drawn from the OECD publication is that New Zealand has undertaken a best-international-practice electricity reform package. As with many other countries, there were stages of the reforms that were pretty rough for some parties; but the end result is much better for consumers, as compared to the monopoly electricity system it replaced.

As uncomfortable as that transition process was for some, the larger, and long-term, benefit of choice and lower prices has been achieved. I would be the first to admit the widespread consumer perception in the New Zealand public is that the introduction of a competitive electricity market has been disruptive and, some might say, has not worked. That is a perception that will be gradually replaced by the facts, hopefully. To return to the old central/local government monopoly days would be folly and a tragedy for consumers.

Indeed, the fact that the Labour-Alliance Government has not attempted to undo the reforms of the last 15 years, and in particular the latest stage of the 1998/99 reforms, indicates the direction of change was correct and in the interests of consumers. Claims by the present Minister of Energy that they "can't" be undone are utterly specious: if his Government wanted to create notionally integrated electricity monopolies again, it could. But to do so would remove competition and choice for consumers, a step which would undoubtedly be opposed by consumers, and to its political cost.

Of course, the perception that the reforms didn't work was accentuated by the 2001 hydro so-called "crisis". Some claim the "crisis" was caused by the reforms. If there was a crisis, it was caused by a lack of water, not the reforms. In fact the competitive market coped better than in 1992 when we last had a hydro crisis. Some companies were excessively exposed to the spot market and did face some weeks of very high prices: these prices have now come back to pre-hydro crisis levels. The higher prices had the effect of reducing demand, and therefore keeping the lakes at sustainable levels.

That is how markets are supposed to work, and is infinitely better than the old system when bureaucrats, or politicians, invariably made the wrong decisions. Any commercial mistakes made (e.g. by not hedging against dry years and buying power substantially through the spot market) are now borne by the shareholders, not by consumers, which is what has traditionally happened. And that is how it should be: consumers shouldn't be the scapegoat for poor commercial decisions.

It is seeping through, after all the criticism that Labour and the Alliance hurled at National in 1998 and 1999 when we were formulating the last stages of the reforms, the present Government does not intend to abandon the competitive electricity market at all. Indeed, Clark and Hodgson have made it clear that the competitive electricity market is here to stay with only minor tweaking, most of which we would support. Is this political hypocrisy, or facing up to reality? You make the decision.

Hon Max Bradford MP
20 April 2002

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