Executive Summary of the MSC Decision

A media fact sheet from M-co, NZEM Market Administrator

At 5:10pm on 8 June 2001, two NZEM Market Participants asked the Market Surveillance Committee (MSC) to investigate whether or not an "Undesirable Situation" existed. Two other Market Participants subsequently made public statements to similar effect.

An 'Undesirable Situation' is "any situation which threatens or may threaten fair, orderly or proper trading on NZEM", this includes manipulative activity; excessive positions; unwarranted speculation; a breach of any law; and/or regulatory action threatening trading or the public interest.

Reduced to their essential characteristics the claims that have been made are, that:

· A Market Participant has market power to an extent that gives that Market Participant the ability to set higher prices than would otherwise be charged on a non-transitory (rather than opportunistic) basis; and

· A vertically integrated Market Participant uses market power in the wholesale market to limit or foreclose competition in the retail market.

Investigation

The Committee instigated three separate processes: · First, to stabilise financial relationships between Market Participants and NZEM

· Secondly, to form a judgement as to whether an "Undesirable Situation" exists in the NZEM:

(i) For any of the claimed reasons;

(ii) If other Market Participants are financially distressed; or

(iii) For any other reason discovered by the Committee in the course of its investigation.

· Thirdly, to investigate whether there had been any relevant breach of the Rules by Market Participants or service providers.

Stabilising Financial Relationships

Coincidentally, to the investigation of the 'Undesirable Situation' the NZEM Clearing Manager and the MSC became aware that certain Market Participants were financially distressed.

The MSC and the Clearing Manager are now assured that the financial condition of these Market Participants will not create an 'Undesirable Situation' by an inability to cover their prudential security. The prudential position continues to be reviewed regularly, but was not a part of this inquiry.

MSC Process

The MSC met with various Market Participants, service providers and other sources. There was open dialogue between all concerned. This included information about:

· Hedges,

· Offers made to NZEM by Market Participants,

· Price forecasts,

· Various models used by Market Participants for predictive and other purposes, and

· Views of Market Participants about the competitive positions of other Market Participants.

The MSC considered not only the spot market administered by NZEM, but also the hedge market and the retail market. The decision on whether an undesirable situation exists is discussed below.

Investigation Into Potential Rule Breaches

The M-co Surveillance and Compliance team is continuing to investigate whether any NZEM Rules were breached because of the circumstances that brought about the allegation of an 'Undesirable Situation'. This investigation is ongoing and was not taken into account during this inquiry.

Decision The MSC did not find that an "Undesirable Situation" existed in NZEM during 2001 and, in particular, in May and June 2001.

No Manipulative Activity Found

None of the information available to the MSC suggested that any Market Participant engaged in manipulative activity, or attempted manipulative activity, under the Rules of NZEM.

The MSC believes the rules concerning "Undesirable Situations" are for the protection of an efficient and competitive spot market. Those rules should not be used to shield particular Market Participants from market forces unless, for example, the consequences of the failure of a Market Participant threaten trading and settlement on the spot market as a whole. The MSC's decision states this is not now the case.

Some Market Participants suggested that a Market Participant in a position to set prices in the spot market and/or the financial hedge market might do so in order to drive another Market Participant from the retail market. The MSC's decision stated, that while this may describe a proscribed use of market power it does not, in and of itself, properly describe a manipulative activity.

Market Power Found to be Transitory

It was claimed that certain of the larger net generator Market Participants have market power in the spot market and in the hedge market because of their small number. The MSC's decision stated, whilst a number of Market Participants may have market power from time to time, such market power remains transitory.BM__ftnref1[1]

No Situation that Threatens Orderly Trading Found

The MSC found no situation that threatens or may threaten fair, orderly or proper trading in NZEM. The MSC stated that the proper objective function of NZEM is to create dynamic efficiency, since this should result in better investment signals and improved consumer welfare over time.

In the MSC's view, it is important, when assessing particular events in NZEM, to recognise the dynamic nature of electricity markets and not to take a static view of each individual episode.

No Opportunistic Use of Market Power

In electricity markets, short-term capacity is costly to vary and short-term demand is relatively inelastic. This can result in substantial price variation. This may not happen smoothly and the MSC believe there is no reason to expect different participants to have the same view about when this will occur.

A key purpose of markets is to reconcile legitimately held but different expectations about the future.

The MSC's decision does not justify current spot price levels but nor can it find them to have been a result of the opportunistic use of market power. The MSC's decision states that ultimately, each Market Participant's individual perceptions of particular risks and opportunities are what matters in NZEM and any Market Participant that complies with NZEM's guidelines and principles is entitled to compete in NZEM as it chooses.

Competition Not Inhibited

The MSC did not find there to be market power in the financial hedge market and has not seen any evidence that particular Market Participants have used such market power as they may have had to limit or foreclose competition in the retail market.

In terms of the retail market, the behaviour of the particular Market Participant complained against was found to be both consistent with its conduct in other locations in the same market and with the conduct of other competitors in the same market. The MSC was not persuaded that the claims made about market power, and about the use of market power to foreclose the retail market, were justified.

Other Issues During its investigation, the MSC also considered issues in relation to the design and operation of NZEM and the hedge and retail markets. The MSC merely notes these issues, without providing a solution. For more information on these issues see pages 31 to 36 of the MSC's decision.

The issues are:

· Oligopoly and vertical integration

· Transmission Constraints

· Demand

· Market design and Rules

ENDS

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[1] For example, when there is an abundance of water net retailers would be expected to have greater negotiating strength (and perhaps market power) than net generators and vice versa in drier years.

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