Infratil Update September 2013 Issue No

Infratil Update September 2013 Issue No. 38 After almost 25 years’ of reform the average New Zealand household electricity bill has risen from $61 a month to $183. Can paying $1,470 more for a year’s power be compatible with an industry getting it right or is it time for a change? * Householder This Update sets out an explanation of the higher costs, “ My electricity bill showing that of the $1,470 average annual increase: has risen, again!” $635 reflects price inflation and higher GST $595 is due to higher line/grid/meter/retail back office costs $240 comes from increased wholesale electricity prices Recently, the Green and Labour parties released proposals which they claim would reduce the Electricity industry guru price paid to generators and ultimately by consumers. We think they have got it wrong and the “ The 25 year industry proposals would hurt rather than help households and would impose other economic costs. This Update explains why electricity prices have risen for households and reviews the Green/ restructure has Labour proposal. delivered efficiency, reliability and vigorous In effect the Update is a submission on the proposal which is tricky as the announcements competition” lack details and specifics. The reason we have taken this step now is because the policies as outlined have the potential to significantly harm consumers and investors in a sector that is critical to New Zealand. Investors recognise that the potential restructure of the electricity market would impose costs on generators, and they have discounted the value of TrustPower accordingly. This is more than just “tough luck for shareholders”, it increases TrustPower’s - and Infratil’s - cost of capital and makes Householder it much harder to make new investments. “ Why has my bill We hope our contribution to the debate will result in a reappraisal and amendment to the policies risen?” and less uncertainty. Politician “ I have seen the light, it’s electric and can be cheaper” It is hoped this Update encourages debate on the issues covered. Those with an interest are invited to make submissions on Infratil’s Facebook page. * The electricity bill is based on 8,000 kWh annual use. The prices are derived from New Zealand average residential prices for the March years ended 1990 and 2013, published by the Ministry of Business, Innovation and Employment. Since 2002 the average price is based on the Quarterly Survey of Domestic Electricity Prices, which has been adjusted to account for the estimated impact of the Contact Energy on-line, on-time discounts. Prior to 2002 the average price is derived from the March year Annual Statistical Returns as published in the Energy Data File. Infratil September Update 2013 Fuel Prices & Fuel Poverty A German visitor to New Zealand 15 years ago remarked on how cold our houses were. Where The political proposal was the double glazing and insulation? suggests a minimum $230 per household At least part of the shortcoming came from electricity previously being cheap; why insulate when electricity cost saving. you can heat? Unfortunately people willing to purchase a drafty house because of low energy Perhaps $170 of this prices were hurt when those prices rose. There is no easy solution or way to turn back the clock. would come directly Government’s response includes subsidised insulation, encouragement of consumers to shop from taxpayers with the around for cheaper electricity, and industry strategies aimed at making the generation, distribution remainder from private and sale of electricity as efficient as possible. owners of generation. Today New Zealand has residential electricity provided via highly competitive generation and retail markets over highly regulated lines. If a householder has made the effort to make sure they are Average household using the most suitable retail plan, they can be confident that their electricity price is a fair cost saving: 10% reflection of the cost of generation and transmission. However, many households in New Zealand are still struggling to keep their homes warm in winter. Industry efficiency: “yeah right”. Perhaps more can be done, such as improving the state of rental housing through “warrant of fitness” standards or the targeted energy-subsidies provided in Australia or UK. The Government backed New Zealand Insulation Fund provides owners of homes built before 2000 with up to $1,300 towards the cost of insulation. Studies have shown that insulation can save approximately 5% of the amount of metered energy used. 215,000 homes have been insulated with the Fund’s assistance, and in 2013 $100 million more was allocated to extend the scheme. $100 million to subsidise insulation is a lot of money, but the cost to taxpayers is much less than the proposed Labour/Green policy. The policy announcement indicated a target of reducing the Share of the saving paid household electricity cost by at least $230 a year; in aggregate about $460 million. for by taxpayers: 74% This would reduce GST by $60 million, income tax payable by generators by about $120 million and the Crown’s dividend from its investment in power companies by about $160 million*. A total cost of about $340 million each year. Private owners of power companies would carry the remaining cost. * Before Meridian partial sale by the Crown What Politicians and Regulators Want and Why (at least until now)? Until the mid-1990s New Zealand’s electricity industry was state owned and managed. There was Bad regulation resulted the construction of power stations such as the Tongariro Scheme, Clyde, several of the Waikato in many New Zealanders stations, the Upper Waitaki, Marsden B and Huntly (to name a few) which came in years late, well buying poorly built and over budget or both. There was environmental damage at Manapouri and elsewhere. There were insulated homes. cheap power deals with large factories processing alumina, iron sands and wood. And there was a crisis when rain didn’t fill the hydro lakes in 1992. The failures and cost over-runs led to industry restructuring. The near-monopoly state generator was corporatised and separated into two, then four, companies. The grid was separated from generation into Transpower, and community owned distribution and retailing activities were transferred into companies. Some of the shares in these businesses were sold to private investors, although over half of the industry is still owned by the state or local communities. The goals behind the restructuring, and the goals now of industry regulation are: Reliability (the lights stay on). Efficiency (costs are as low as possible). Equity (users pay what it costs the industry to supply them and only that). “New Zealand owned”, “government/community owned”, “green/sustainable”, “minimising energy poverty” and other social or environmental objectives can be pursued (or not) without compromising the three main goals. Since the restructure of the electricity industry commenced in the 1990s, the three goals have been paramount. No-one would say nirvana had arrived, and a lot of the learnings have come “the hard way”, but reversing the reforms would be a huge step backwards and a departure from the careful and considered approach followed to date. Bad regulation has big costs. The global financial crisis resulted from bad regulation of the banking industry. Bad regulation of California’s energy sector resulted in the Enron debacle and black outs. Bad regulation resulted in many New Zealanders buying poorly built and leaky homes. Bad regulation of New Zealand’s $40 billion electricity sector will ultimately mean higher costs and less reliability. The complexity of the industry and its importance are reasons why a series of Governments and Ministers have been careful when initiating change and have relied heavily on experts within the Ministry and agencies such as the Electricity Authority and the Commerce Commission. The 2009 Government industry review is an example of a thorough and well researched piece of analysis. It noted “Using the LRMC benchmark, there is no clear evidence of the sustained or long term exercise of market power” or expressed in English; based on the long–term cost of new power stations wholesale electricity prices are fair. The 2006 review undertaken by the Labour Government arrived at similar conclusions and actually rejected much of what is now proposed in the Labour and Green policy. Responding to the 2009 review National’s Gerry Brownlee, the Minister since taking over from Labour’s David Parker in 2008, instigated changes to make the market more transparent and to increase competition. These steps were consistent with the approach of previous Governments which have supported the overall direction of reform and the three key objectives (Labour, National, National/NZ First, Labour/Alliance/Progressive and National/United/Maori). Privatisation, which is about ownership not industry structure, has been the only really politically divisive issue. Infratil September Update 2013 Why Have Household Electricity Prices Risen? Since 1990 the average price of household electricity has risen from 9.1 cent/kWh to 27.4 cents/ kWh and the average annual cost from $725 to $2,195. Of this uplift $635 reflects consumer price inflation and GST (GST is now $286 as against $77 in 1990). $595 is the higher real cost of line/grid/meter/back office (“cost to serve”) charges. $240 comes from increased real wholesale electricity or generation costs. The following graph sets out the costs behind the rise in household electricity prices. It shows the changes in real 2013 dollars, therefore the 9.1 cents/kWh 1990 price is inflated to 15 cents/kWh to be in 2013 dollars. The period 2014-2016 is a projection of average household prices based on observed wholesale energy contract prices, expected grid charge increases, and with other costs kept stable.

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