20 Years Ago...
Gary Holden, Friday, 11 November 2016
It is hard to believe that 20 years have passed since I had the opportunity to participate in the boiler room that developed the New Zealand Electricity Market (NZEM). The experience was made particularly memorable as I explored the uncharted waters with seven amazing, world-class engineers, economists and electricity professionals.
The Wholesale Energy Market Design Group (WEMDG) was ably chaired by the Honourable Jim McLay, who proved to be the perfect choice to herd all these cats with competing interests. I distinctly remember his opening address to us in which he established the modest goal of making the NZEM the “best example of a deregulated market in the world”. His voice still echoes with inspiration, even now.
Looking back, we did pretty well. The first mandate was to allow independent power plants to enter the market and relieve the government from the burden of using its own balance sheet to fund growth in the market. The myriad of technical choices was changing fast and unleashing market forces seemed inherently prudent. This was accomplished; the country built two natural gas-fired combined cycle power plants within three years of completing the initial market structure.
As one of the lead hands on the development of those plants, I can say with certainty they would not have been built without the safety net of rules and open measures of fairness. Since the Stratford Power (TCC) and Southdown power plants, over 40 different generators have entered the market, a truly great result.
I was personally gratified by taking the New Zealand wholesale model to Alberta in 1999 and witnessed the adoption of the same rules for producing an energy-only market price there. As with New Zealand, those rules have also stood the test of time and still operate today.
WEMDG’s second mandate was to allow consumers to have choice through the removal of franchise areas. This principle put discipline on lines companies and energy re-sellers to be innovative and cost effective.
With more than 20 energy retailers and more than 30 brands in the market today, consumers have more choice here than anywhere else on the planet – clear testimony to the power of the free market principles set in place in 1995.
The favoured phrase of the day was “the devil is in the detail” and we worked more than 1,600 hours over a little more than a year to present the first set of recommendations.
As the representative standing in for independent (non-ECNZ) generators, I felt enormous pressure to find a set of rules that could introduce ample competition and also allow ECNZ to stay as a dominant market player.
In the end this turned out to be impossible and, with great reticence for some, we delivered a second set of recommendations that explained the imperative of breaking ECNZ up into several entities; a story known all too well by now.
Those were heady days indeed. Technology was ambiguous and conceptual. We imagined it being important to have half-hourly pricing for generators but also to reflect that pricing through to consumers on a half-hourly basis as well. With a blank sheet of paper we were able to think without restriction and establish principles that somehow could withstand a great deal of the vast unknown.
How brilliant were we?
Climate change, and the impacts it has had on global markets, we did not see coming whatsoever. Fortunately with abundant hydro and geothermal we have been able to carry on with a smug degree of calm. We did not expect to be pricing carbon that is for sure and electric cars were purely science fiction in 1995.
We talked a great deal about the future for customers. We imagined day-ahead bidding for cheaper blocks of power by consumers and we imagined wall-mounted devices that displayed hourly price signals so consumers could shift demand to save money.
We heard from a long line of international experts who claimed computers would be in every home and they would turn things on and off with a live feed from the local lines company.
We heard about new technologies that would reduce demand for lighting and appliances. Heat pumps would be in every home and controlled from the smart meter. Most homes would be generating their own power, through solar panels, wind turbines on fence posts or sterling engines nestled in the laundry. The latter would also provide waste heat to dry clothes or heat bedrooms. All of this, I say sheepishly, was to be common place within 20 years.
Light-handed regulation is a rich environment for creativity in traditional areas as well. In board rooms, parallel to WEMDG, we introduced new accounting principles, notable ODV, which would allow lines companies to optimise and revalue assets to enable delivered prices to rise such that these new technologies could enter the market without subsidy and provide lines companies capital to navigate in this rapidly changing world.
An effective combination of time-of-use real time pricing and ODV principles, we reasoned, would invite distributed generation without the need for what later were called feed-in tariffs.
On other committees, such as the transmission pricing committee in 1997, we set the foundation for distributed generation credits to enable investment dollars to flow to small generators, and not always to transmission lines, to meet demand. This one idea was highly effective in creating supply and competition by dozens of generators since then.
So what are the lessons after 20 years?
We have since learned several big lessons. Notwithstanding the openness of the rules, the market still had to work, and as you know, the painting is often more colourful than the scenery.
The cost of technology, daily life and technical reality got in the way. It turns out that smart metering and home automation are two different things. It turns out distributed generation is not particularly welcomed by most lines companies. It turns out that, with the exception of a select few, mass market consumers are not so keen to “play the market” every day to save a few bucks. They are keen to choose better prices, and enjoy the notion of choice, but largely they want retailers to do the hard yards and get them solutions that are easy to digest. After all, it turns out, there are more important things to deal with in life than your electricity account.
As was the case in all deregulating processes across the planet, we had to make compromises and concessions to get the primary mandates through government. To the chagrin of many lines companies, the Max Bradford reforms prohibited lines companies from retail. It turns out that the perception of an unfair advantage was simply shifted to a different list of potentially unfair advantages and the prohibition was lifted within 10 years.
Other markets prohibited generators from retail for similar reasons. However, in this game, 10 years is a long time and the years of generator dominance have left lines companies with large barriers to re-enter.
With solar power, time-of-use pricing and electric cars on the near horizon, those lines companies could add a lot of value to consumers in these new areas. It is a big hill to climb that, in hindsight, was a concession not worth making in 1999. Having said all that, it is now a new day and with the door open again, the ambitions and possibilities that were lost will, no doubt, reform.
We were also quite naive and under-estimated the role a regulator would ultimately have in shepherding the nuances of market evolution. We did not contemplate the need for an Electricity Authority that would, in the end, have a seemingly endless list of maintenance tasks to keep the friction down.
Free markets, it turns out, are not free of regulation. In fact, we have learned that a truly open market might require more regulation; the more players that buzz around the opportunities, the more inclined they are to trigger the need for more rules. It is now clearly evident that light-handed regulation needs heavy-handed rules.
Some notable issues needing attention are as important as the original mandate.
For example, it is clear now that generator dominance in retail breeds an illiquid wholesale market. Wholesale market “bid-ask” spreads are a deadly barrier to success for small retailers in a thin margin market. The long wait for solar power without feed-in tariffs may be stymied by ballooning fixed lines charges. Distributed generation, now in place, seems less interesting to transmission planners. Generators may start to act irrationally as the 30 brands gnaw at their historic customer bases. All are issues requiring constant monitoring and intervention.
What would WEMDG say if it were assembled today?
First of all, Jim McLay would still say we can have the best example of an openly competitive market in the world. There is no reason why this cannot be the claim made in perpetuity in New Zealand. We have the foundation and the will and an EA that can constantly seek improvement with the same spirit as WEMDG shared in 1996.
Clearly, speaking for everyone around that table is an impossible task, but I would hope that if WEMDG was reassembled to debate once again, it would feel empowered to be undeterred in the strong head winds of political power, in the same way ECNZ was pushed to split up.
I would also hope it would insist on a greater volume of tradable wholesale power and drive for negligible spreads in clearing wholesale contracts to have a level retail playing field. You would expect they would apply a severely firm hand with indiscretions made by generator-retailers – in the same way the Bradford reforms swooped in on lines-retailers in 1999.
I would like to think they would have supported the expansion of backbone transmission, largely brought on by the Tiwai Point smelter going away (to ensure Manapouri output could reach Auckland). However, the method of allocation of those costs would have been hotly debated. I would like to think the principle of “butter spreading risk mitigation cost across everyone” would have carried this debate at the end of the day.
Similarly, the value of credits (or avoided cost) for distributed generation seems to have lost support, even though the rest of the world is moving firmly in this direction. Hopefully the pendulum on those issues will swing back to the middle as it almost always does.
We know that smart market players will always test the fence for holes. “Building barriers to entry” was a dirty word in 1996 and we learned, above maybe all other lessons, that the Commerce Commission cannot be the only guardian to creating fair competition. Let’s hope we do not forget that important lesson.
The foundation established by WEMDG has been remarkably durable and all of you who were around that table should be immensely proud. The sustainability of the rule base, the drawing in of multiple sources of international capital, the ultimate floating of the ECNZ offspring, the vast collection of retail competitors, the smooth integration of time-of-use metering, the creation of the Electricity Authority, and the readiness for solar power and electric cars is an awesome collection of achievements that could mean we already have the best market in the world.
Gary Holden ran TransAlta's New Zealand business at the time of the implementation of the New Zealand Electricity Market. He returned to New Zealand and took on the role of chief executive of Pulse Energy in 2013.
The original article may be viewed here.