Tuesday 30 March 2004
Lack of robust hedge market means consumers could be paying too much for electricity
New Zealand’s underdeveloped electricity hedge market could be contributing to retail consumers paying too much for
electricity, according to Carl Hansen, Chief Economist at Mco.
In his speech at today’s National Power Conference in Auckland, Mr Hansen said “retail consumers may be paying higher
electricity prices because current arrangements make it risky for independent retailers to enter the market. Because all
the major generators own retailers, independents are forced to buy hedges from their competitors. This wouldn’t be a
problem if there were many generator-retailers in the main energy regions, but in most cases there are only two or
three."
Mr Hansen added that the lack of a robust hedge market gives large consumers little confidence they are paying
competitive prices for their hedges.
“As a result, many large consumers are failing to buy sufficient hedge cover, which means the market does not send
appropriate price signals about the value consumers place on reducing the risk of supply shortages during dry years.
This leaves generators with weak incentives to invest in capacity ahead of time to meet growing consumer needs,
especially during dry years."
Mr Hansen identified three key factors contributing to the lack of a deep hedge market in New Zealand – the lack of
independent retailers, a scarcity of market makers, and market power concerns.
“Market makers play a critical role in developing liquid hedge markets, because they stand in the market ready to buy
and sell contracts at posted prices. The few market makers active in the mid to late 1990s largely disappeared when
ECNZ’s hedge auctions made secondary market trading of contracts difficult. The 1998 reforms, which required separation
of retailing from lines businesses, were the final nail in the coffin for market makers."
The Marketplace Company Limited Level 2, 10 Brandon St, Wellington, New Zealand Phone + 64 (0)4 473 5240 Home Page
http://www.m-co.co.nz Email info@m-co.co.nz He added, “Market power concerns haven’t helped. It appears that consumer
groups take the view that the Government can’t stand back from high spot prices during dry years, because electricity is
an essential commodity. Why buy hedge market protection against high spot prices when the chances are the Government
will cap prices for you anyway, or initiate a national conservation campaign to reduce electricity consumption to reduce
spot prices?"
Mr Hansen applauded the Electricity Commission for publicly identifying the development of a transparent and liquid
hedge market as a top priority for the coming year. He said the key to achieving this goal will be developing a solution
that provides a ‘level playing field’ for independent retailers to compete with generator-retailers. Forced separation
of generation and retail is not likely to be the answer.
“One option is to facilitate the development of blind hedge markets, where buyers and sellers transact through a third
party such as an exchange or through brokers. Standard insider trader policies should be imposed on generator-retailers
to prohibit their generation businesses feeding information to their retailing arms before informing the rest of the
market."
Mr Hansen also said there could be a case for encouraging market makers back to the hedge market.
“Developing a liquid market requires market makers to offer thin margins between bid and offer prices, to achieve large
trading volumes. But market makers may not be willing to bear those risks if competitors can subsequently enter the
market and erode their margins where they haven’t contributed to the costs of developing the market. The Commission may
wish to consider developing policies that give original market makers greater confidence their investments will not be
eroded by ‘free riding’ competitors."
-ends-