A range of submitters argued for greater regulation of the wholesale market in recognition of the essential nature of a secure electricity supply to the wellbeing of the economy and the public.
Some submitters suggested that supply and demand should be better co-ordinated in the public interest.
Several suggested that the regulator (be it the Government or another body) should manage supply and demand to protect the public interest and prevent opportunistic behaviour by generators. For instance, Grey Power and Sinclair Knight Mertz argued that during shortages the Government should take control of the market in the national interest.
Transpower argued that the concept of industry self-governance is likely to fail and that regulatory intervention is likely to be required if the full intent of the Government Policy Statement is to be realised.
Network Tasman argued that SOE generators have greater "public good" responsibilities than pure private sector companies, and that this should be a consideration in dry year situations to ensure that the public interest is protected.
Network Tasman also pointed out a potential conflict of interest in market regulation by the Government, given the significant SOE stake in the generation market, and suggested that regulation should therefore be devolved to an independent body.
Sinclair Knight Mertz recommended abandoning the market altogether, and appointing a system operator/trader to manage system security and shortages, purchase power from generators at agreed prices, tender out for new capacity and sell to consumers on a cost recovery basis. Grey Power's cross-submission said that, unless the Government was prepared to change the role of the SOE generators in the public interest, then they would support the SKM recommendation.

"The market must be managed from a resource perspective rather than as a revenue generator" - Waikato DHB.

"The Government has to decide whether generation should be done in the best interests of consumers or investors... The generation industry no longer works as a co-ordinated whole with strong points propping up weak points... SOE generators should be amalgamated and required to act in the interest of ensuring low cost reliable electricity supplies to consumers. This will counter the parallel behaviour of larger generators in driving prices and restore a measure of co-ordination in generation" - Grey Power.

CC93, Fletcher Building, Grey Power, Robbie Morrison, Network Tasman, Sinclair Knight Mertz, Transpower, Wallace Corporation, Waikato DHB

Other submitters argued that greater regulation is not required, and that Government intervention to manage supply and/or demand would be inappropriate. They said that the market provides the best means of managing risk and sending signals to both suppliers and consumers.
NZEM's cross-submission argued that it has a track record of secure and reliable operation of the electricity system, coupled with efficient pricing, and that regulatory intervention often involves higher economic costs than self-governing arrangements.

"The NZEM price discovery mechanism will continue to deliver the optimal outcome through time. Short-term dislocations such as have been experienced recently have been fully signalled and market participants in response have already made many decisions about the way in which they manage their exposure to spot prices" - NZEM.

"NZ hydro storage is small in comparison to other countries, and subject to considerable weather variability. We have had tight supply in the past and we will again in the future. Our past experience has strongly suggested that market mechanisms are a preferred way to manage that variability" - Meridian.

AICon, Business NZ, Business Roundtable, Federated Farmers, Infratil, Meridian, NZEM

The idea that regulation was required to protect participants from market risk was countered by the argument that risk management was the responsibility of the participants themselves.
Meridian commented that market risks are inherent given the volatile nature of New Zealand's electricity industry, and argued that market mechanisms are the best way to manage that variability. Those who choose to take risks must face the consequences of doing so. This was reiterated in the Government Policy Statement - Management of Dry Year Risk.¹
NZEM pointed out that risk management is the responsibility of each member of the industry, each of whom has a view on the best approach:

"The various approaches to managing spot market price risk may, over time, enjoy varying rates of success. The approach taken within NZEM has always been to rely on members managing their exposure through their own risk management processes" - NZEM.

3.2 Supply Side

Summary of Key Points

Various approaches were suggested to increasing the supply of reserve generation, including creating market incentives for generators, establishing various insurance schemes and imposing legislative requirements on generators. The importance of ensuring the market provides genuine incentives was noted.
The need for incentives to facilitate investment in new renewables (particularly geothermal) and distributed generation (and to remove market barriers) was noted.
The further break-up of generating companies to increase competition was suggested.

Encourage New Generation (General)

Grey Power's cross-submission suggested that, if the wholesale market price is insufficient to encourage the construction of new generation capacity, then the Government should either provide new generation or generators should be forced to.

Diversify Generating Capacity

The development of new non-hydro generation capacity was recommended, in order to provide greater stability in the generation market.
The New Zealand Geothermal Association submission supported the greater use of geothermal energy, arguing that this is a sustainable and reliable energy source with environmental advantages over natural gas.
David MacClement suggested the construction of wind turbines throughout the country.

Encourage New Renewable Generation

The Government needs to act upon its commitment to reducing greenhouse gases and constructively encourage, promote and assist in the development of renewable electricity generation plants (TrustPower).
Provide an incentive to encourage the development of reliable generation that produces low greenhouse gas emissions, such as through a carbon emission regime (regulated, tradable or taxed), a mandated renewable target, a subsidy on renewable generation, or a penalty on non-renewable generation. In this context geothermal and hydro should be classified as "renewable" following the Australian model (Geothermal Assn.).
According to the Geothermal Association,

"Electricity from geothermal energy is [currently] more expensive that that from natural gas. The difference is relatively small and could be offset by a relatively small change in the relative cost of hydrocarbons... For these reasons we strongly support the development of a National Policy Statement under the RMA covering sustainability and balancing of environmental effects, and the imposition of some form of positive incentive regime."

The Association recommended changing "Section 46A `Exemption for new distributed generation from new renewable energy source' clause subsection 4(b) of the Electricity Industry Reform Amendment Act 2001 to allow a greater threshold for new geothermal and hydro plants," thereby making them more competitive with gas generation.

Encourage New Reserve Generation

Develop a system to reward generators for maintaining low capital/high operating cost reserve plant. This could involve an agreed levy on all market volumes to support capital holding and maintenance costs for reserve plant and an agreed offer price in the event that the plant is dispatched (Network Tasman).
Change the rules to force generators to provide reserve plant to cope with hydro shortfall. This cost would then be incorporated into the price of hydro electricity (Peter Kammler, Grey Power).
Require hydro owners to hedge their dry weather risk by paying owners of reserve plant (Network Tasman).
The Electricity Governance Board should develop a dry risk insurance scheme, whereby thermal generators are invited to tender for provision of reserve generating capacity to mitigate against dry year risk. The benefit would be to define the cost of dry year insurance well in advance, facilitating the incorporation of risk management cost into electricity charges (Fletcher Building).
Make the security of supply a commodity which consumers can opt to buy. Consumers would have the option of buying electricity at a low tariff, and facing the prospect of a shortage, or paying a higher tariff in exchange for a guarantee of supply. This would suit consumers who need electricity so badly that they have their own backup anyway (e.g. hospitals, cool stores, isolated dairy farms). This allows the market to find the lowest cost for security of supply because it can be tendered out (Peter Kammler).
The Sustainable Energy Forum suggested reconfiguring the market to provide a series of "frontline" power stations (including some new ones) which are the most efficient and which can compete with one another on price, backed up by "reserve" power stations for use in times of hydro shortage.
The owners of these reserve stations would be paid a subsidy to cover maintenance costs. An overall controlling authority would be responsible for determining the level of reserve capacity required. Suggested advantages of this proposal included:

older thermal power stations would not need to be decommissioned;
the controlling authority could set a wholesale power price threshold to "trigger" the entry of reserve stations into the market; and
taking the "reserve" power stations out of the market during intervening years would give developers of renewable generation more confidence to invest.

This idea was supported by Pan Pac's cross-submission.
Contact's cross-submission said the company was not opposed in principle to the payment of a reward for providing reserve capacity, but would wish to ensure that any payment mechanism was sufficiently robust to create genuine incentives to invest in reserve plant. Contact suggested that a similar mechanism might evolve de facto in the hedge market, whereby buyers purchase contracts that cap the price of their wholesale market purchases, in return for a fixed up-front payment.

Signals to Prompt Entry of Reserve Generation

Several submissions commented on the need to establish triggers to prompt the entry of reserve generation. Mighty River Power said the market must ensure that thermal capacity competes within the market to provide an early response to low hydro capacity. MEUG's cross-submission agreed with this, but suggested MRP should be asked for suggestions as to how this might be facilitated.

Review Behaviour of Thermal Generators

Noting the level of disagreement between submissions as to whether thermal generation had responded appropriately during winter 2001, MEUG's cross-submission recommended an investigation of thermal generators' behaviour, to determine whether they had acted anti-competitively.
Comalco's cross-submission also recommended an independent review of thermal utilisation from January 2001 forward.

Increase Competition among Generators

Pan Pac and Infratil recommended that the break-up of generation companies to increase competition.
Pan Pac suggested the Government should separate the thermal generators from the SOE Genesis, and either privatise or establish separate SOEs for them. Pan Pac argued that greater competition between thermal generators would improve the incentive to dispatch more thermal generation, and reduce dependence on hydro generation.

Facilitate Distributed Generation

Market barriers to the introduction of distributed generation need to be addressed. Benefits of distributed generation would include the alleviation of grid constraints, line losses and harmful emissions (CHH, Todd Energy).
As a means of encouraging the provision of distributed generation, Pan Pac suggested that generators could be required to cover all of Transpower's costs, based on the extent of their demands on Transpower's network.
Pan Pac argued that because the cost of supplying local retailers would be lower, this would provide an incentive for distributed generation. Generators would be less inclined to withhold supply to drive up the wholesale electricity price. Consumers would benefit because the variable wholesale electricity price would include Transpower costs, thus consumers would be charged higher variable costs and lower fixed costs.

Relax RMA Constraints on Hydro Generation

Mighty River Power argued for more flexible hydro resource consent conditions in order to increase the competitiveness of hydro generation relative to thermal generation at times of peak demand. This would increase daytime competition, leading to lower end user prices.
MEUG's cross-submission also recommended the Government explore options for greater flexibility of resource consents for hydro generators.

Reduce Waste in Generation and Delivery (Including Hydro-Spill)

The efficiency of supply and delivery needs to be improved, along with the reduction of waste. The Electricity Governance Board should have a research capacity dedicated to improving the efficiency of generation, transmission and distribution. The Electricity Governance Board should co-ordinate with EECA on this matter (Brian Tolley).
Hydro generators should be required to disclose all hydro spill information. This would ensure efficient management of hydro resources (Mighty River Power).
Spill should be regulated to ensure that it is not done wastefully (David Renouf).
Cost penalties should be imposed for hydro spill to prevent it happening (Sustainable Energy Forum).
If there is a need for hydro spill in the Waitaki hydro system, it should be done in such a way that it benefits the overall storage capacity of the Waitaki River system (John Blakeley and Bruce Hunt).
The Government should request an explanation from Meridian Energy as to why 1.85 metres was spilled from Lake Tekapo over January and February 2001 (MEUG).

3.3 Demand Side

Summary of Key Points

Many submissions recommended that all end consumers be exposed to some degree to wholesale price volatility in order to improve demand side response. Others cautioned that domestic consumers were not well-placed to respond to short term price rises and would prefer price certainty over volatility.
Some support was expressed for real time pricing as a means of facilitating demand side management. Others said the effectiveness of a real time market would be limited by consumers' limited ability to respond.
It was suggested that significant advances in demand side management would be made possible by updating local distribution technology and better management of load through local lines networks.

Improve Price Signals to Consumers

Market reform is needed to ensure price signals are felt across the entire market. Retail prices should include an element of spot price exposure.
The benefit is that consumers would be charged an overall lower price at times when the floating rate (spot price portion) is low but would see a signal to conserve when the hydro lakes are falling and the floating rate increases. Savings would be encouraged by a higher variable cost component in retail tariffs.
Drawbacks include:

the risk of considerable additional administrative complexity and some additional costs; and
an inherent conflict arising from the fact that system responsiveness requires price volatility whereas customers prefer price stability.

Business NZ, Fletcher Building, Genesis, Robbie Morrison, Network Tasman, Bill Heaps (Transpower), Waikato DHB

The Government should examine how price setting occurs in the market in times of shortage, and whether this price signal translates into an efficient demand control mechanism (Mark Pickup).
In response to the above suggestions, Grey Powers' cross-submission argued that domestic consumers were the least likely to respond to short term price increases, because of the significant delay between consumption and billing. In addition, they argued that exposing domestic consumers directly to spot prices would cause considerable domestic hardship and political dissatisfaction.
Grey Power argued that industrial consumers were better placed to respond quickly to spot prices. As an alternative to exposing domestic customers to wholesale prices, they suggested that in crisis conditions, bilateral hedge contracts with large industrial consumers could be cancelled, thereby achieving significant savings by encouraging demand reduction by a few very large consumers.
In its cross-submission, Meridian argued that consumers (particularly domestic consumers) should be allowed to choose financial incentives to conserve energy during dry years. Such measures, it argued, should not be forced on them.

A Real Time Market (RTM) to Improve Demand Side Participation

Transpower, Mighty River Power, the Health Sector EBG, and Bill Heaps (Transpower) expressed support for an RTM. They argued that an RTM could potentially improve demand side participation by allowing wholesale purchasers to respond quickly to high prices, and this would increase competitive pressure on generators by creating more elastic demand.
Transpower said in its cross-submission that it is pursuing the development of Real Time Pricing through "appropriate industry working groups."
In response, Contact's cross-submission argued that had an RTM been in place prior to winter 2001, this would not have significantly changed the outcome for the industry as a whole.
NZEM identified a number of possible limits to enhancing demand side participation through use of an RTM:

increasing the number of consumers that can participate in the market would involve more consumers being exposed to the spot market;
the ability of consumers to respond to prices may be constrained due to the physical characteristics of plant or operational requirements; and
real time pricing would not improve consumers' ability to react in times of prolonged high prices.

The 2 Hour Rule

Several submitters criticised the 2 hour bid rule (whereby demand side bids into the market cannot be changed within 2 hours of real time), saying it impeded access to timely market information and therefore demand side management.
MEUG recommended that the Government request that Transpower reply in writing to MEUG's suggestion (27 June 2001) that the 2 hour rule be changed to align with the recommendations of the Demand Side Participation Sub-group to facilitate effective demand side management.
In its cross-submission, Transpower argued in favour of the 2 hour rule, because allowing parties to change their bids at short notice would create problems for the system operator in terms of accurately predicting demand response and identifying security management issues.
Contact's cross-submission also argued in favour of the 2 hour rule, saying the rule's rationale is to promote grid security. It pointed out that demand side participants are currently permitted to alter their demand in response to price changes within the 2 hour period, provided they do so in accordance with a demand bid they have previously made.

Better Management of Load through Local Lines Networks

Several submissions advocated better use of "ripple control" to manage peak load demand.
Genesis suggested that "commercial arrangements should be structured to allow the retailer to shift load to time periods which can be covered by thermal generation, or else scarce hydro resources will be used to provide this generation in peak times."
Carter Holt Harvey argued ripple control would help to "reduce volatility and overall prices".
MEUG's cross-submission recommended that the Government examine whether there are any barriers to the efficient use of ripple control by retailers and lines companies, and if so, how those barriers can be removed.
WEL Networks said the capacity of line companies to monitor and predict load in their supply areas should be utilised. For example, some lines companies have data management systems that allow them to compare consumption with historical trends on a feeder-by-feeder basis.

Update Local Distribution Technology

Bill Heaps (Transpower) said that increased availability of time of use meters at residential and small commercial sites would improve opportunities for customer response to spot prices.
Brian Tolley suggested there is a need to update frequency, load management, communication and metering arrangements for local distribution in order to improve efficiency and demand side influence on the market. Specific points made included:

Overcoming technological limits to domestic electricity profiling would improve options for demand side management;
Time of use metering for 3 phase should be required; and
Responsibility for metering, switching, registration, billing, reconciliation and demand side load management should be separated from the retailers and be offered as a service in each network to retailers competing in that network.

Brian Tolley's cross-submission explained how making the above changes would facilitate many of the improvements advocated by other submitters, including the change from marginal to average loss pricing advocated by Todd Energy.

3.4 Transmission

Summary of Key Points

Many submitters recommended upgrading the national grid to remove constraints and improve security.
It was suggested that better incentives are needed for transmission investment and a long-term strategic approach to investment should be taken.
Transpower recommended developing contingency plans to cope with constraints in times of supply shortage, and also noted that a constraint-free grid was not a realistic proposition.
A review of the treatment of transmission rentals by lines companies was recommended.

Address Transmission Constraint / Security Risks

Constraints should be removed to ensure that reserve capacity can be utilised when supply problems arise, to improve competition and reduce opportunities for regionalised markets to develop (NGC, Mighty River Power, Sustainable Energy Forum).
Processes are needed to ensure that appropriate investment in transmission is undertaken (Fletcher Building).
There is a need to establish a process to examine and remove grid constraints where this is shown to be in the national benefit (Network Tasman).
Transpower have released a discussion document (System Protection Schemes for Transmission Capacity Enhancement) which considers how the System Operator might in future be able to more actively manage the grid and security parameters. MEUG agrees this should be a focus for Transpower. Steps should be taken before winter 2002 to ensure grid enhancements are assessed and implemented in a robust and timely manner (MEUG).
The Government should ask Transpower to consult with stakeholders and the Grid Security Committee on how the existing grid capacity can be enhanced for winter 2002. In addition, Transpower should report on new forward grid investment for the period winter 2002 - winter 2007 (MEUG, Business NZ).
Transpower should be empowered to develop the grid to ensure the lowest cost transmission without the current impediments that have precluded grid development since the market was implemented (Pan Pac).
Recognising the potentially significant economic consequences of grid operating decisions, the NZEM Rules Committee expressed support for greater transparency surrounding Transpower's decision making.
Transpower recommended the development of industry-supported contingency plans for grid reconfiguration, temporary relaxation of security standards, etc.
Transpower also noted that making significant grid changes, such as to relieve constraints to supply from Taranaki, were not a simple matter and would require significant technical analysis and planning.

Facilitate Transmission Investment

Introduce a financial instrument that sharpens Transpower's incentives to maximise the ability of the transmission system to transfer energy, as opposed to focussing heavily on achieving a specific level of transmission system reliability (Meridian).
Meridian pointed out that the intent of Part F of the proposed rulebook is to address the problem of insufficient grid investment. Meridian argued, however, it is essential that the transmission investment rules developed are practical, and that the resulting pricing methodology does not undermine market efficiency.
Energy Link stressed the need to examine whether the right objectives or incentives are in place to ensure that reasonable trade-offs are made between transmission capacity, short term and dry year local and national security of supply, spot prices, and the cost of measures to increase grid capacity.
Sinclair Knight Mertz suggested the Electricity Governance Board should be authorised to allocate transmission rentals to fixing constraint, security and loss problems.
Transpower identified the need for a long-term, strategic approach to transmission investment, with the goal being to achieve an efficient level of transmission investment in the future. This, they suggested, would require occasional "regulated" enforcement of investments where such investment was demonstrated to be in the public interest but where commercially agreed investment decisions are not forthcoming (as signalled in the Government Policy Statement).
In its cross-submission, Transpower explained that a number of new grid investments and other performance upgrades were planned prior to summer 2001 (to ease security or supply problems into Auckland) and in preparation for any possible repeat of the conditions seen in winter 2001.

Investigate Inequities in Transmission Rental Rebating

The Government should investigate whether lines companies' treatment of transmission rentals had any equity or competition affects (over the winter 2001). If so, steps to remedy problems identified should be explored (MEUG).
The Government should review the treatment of loss and constraint rentals and if necessary regulate their removal or the allocation process (TrustPower, Contact's cross-submission).

Ownership / Governance of Transmission

The Government should convert Transpower into a Crown Owned Company, and clearly establish its responsibility "to deliver electricity in an efficient, fair, reliable and environmentally sustainable manner" (in other words, to deliver least-cost system solutions to the industry). This would be consistent with the Guiding Principles of the Government Policy Statement.

Alliant International, Pan Pac's cross-submission, TrustPower

Sinclair Knight Mertz recommended appointing an Independent System Operator (ISO) to manage transmission and fix constraints. This would help to ensure an economical and reliable supply of power.
In its cross-submission, Transpower said that the present reform process provided an opportunity to review the incentives under which it operates. Transpower said, however, that it is important to ensure that any changes to Transpower's regulatory framework, and any resultant changes to its incentives, occur in a manner that ensures:

Consistency between these various regulatory mechanisms; and
Consistency with the efficient functioning of the wholesale physical market.

3.5 Risk Management Instruments

Summary of Key Points

Many submissions advocated greater liquidity in the hedge market and greater availability of hedges.
The mandatory offer of hedges was suggested by some to improve retail competition.
Opponents of mandatory hedges said that denying companies the full benefit of internal hedging would lead to increases in spot prices and less overall system security.
Support was expressed for the development of financial transmission rights (FTRs) as a means of hedging against transmission loss and constraint risks.
A number of reservations were expressed regarding the introduction of FTRs, particularly in terms of their potential to exacerbate generators' market power. Market competition issues should be addressed before FTRs are introduced.

Mandatory Hedges (Countering the "Natural Hedge" Strategy)

A range of submissions argued that vertically integrated generators should be required to offer a proportion of their hedge volumes to third parties at the same price as they offer to their retail businesses. This would help to boost liquidity and place all retailers on a more even footing.

Alliant International, Business NZ, CHH, Comalco, Fletcher Building, MEUG, Network Tasman, Transpower

On the other hand, the Natural Gas Corporation said that careful analysis was needed as to whether mandatory hedges would reduce the benefits from hedges tailored to specific circumstances, or remove the opportunity for vertically integrated companies to internally manage wholesale price risk.
Contact's cross-submission argued against mandatory hedges. It said that denying vertically integrated companies the full benefit of internal hedging would increase the cost of risk management (leading to increased prices for consumers), and increase the likelihood of domestic and small business consumers becoming directly exposed to spot prices.

Develop Long-Term Contracts

AICon suggested that a long-term contracts market should be developed. This would improve price stability for consumers, improve information and incentives for new investment, and improve generators' ability to handle the risks of shortages.
According to Infratil, regional market fragmentation creates a major barrier to the effective operation of the contracts market. "Emphasis needs to be placed on ensuring as much competition in the contracts market as possible and that means as much tradability and liquidity as possible" - (Infratil)

Financial Transmission Rights (FTRs)

Support was expressed for the proposed FTRs. Suggested benefits included:

protection of market participants against the costs of transmission constraints;
improved competition;
FTRs are entirely funded by and reliant on rentals, and without rentals cannot be offered by Transpower or any other party; and
the revenue from sales of FTRs is used to reduce charges for the sunk and fixed costs of transmission in order to minimise distortion to market efficiency.

Transpower suggested that FTRs represent the most efficient means of using transmission rentals.

"Transmission risk management tools such as physical capacity rights, or financial transmission rights are absolutely vital to promoting competition, and the continued inaction in implementing them serves no one but generators intent on creating regional monopolies with captured retail customers" - Alliant International.

"The benefit of a competitive FTR market is that it will facilitate more competition across constraints and thereby reduce the tendency for regionalisation in the primary hedge and retail markets. The costs... are that a wide range of other changes are needed to the energy market to improve competition and the [associated] cost of software and administration" - MEUG.

Alliant International, Infratil, Meridian, MEUG, Network Tasman, Sinclair Knight Mertz, Bill Heaps (Transpower),Transpower, TrustPower

A number of reservations were expressed, however, and a range of adjustments to the design of FTRs were suggested.

"The current design proposal for FTRs sees Transpower assuming little or no risk. [The industry's preferred option] would involve Transpower having incentives to maximise the ability of the transmission system to transfer energy in response to changes in market conditions. The current FTR proposal where Transpower scales back payments following a reduction in rental income caused by circuits being removed for maintenance, or unplanned outages, fails to achieve such incentives" - Meridian.

"The effectiveness of FTRs... will depend on... whether the lack of generation competition within specific constrained regions will enable the FTR market to work properly" - TrustPower.

In its cross-submission Transpower agreed that FTRs alone would not solve the industry's investment problems, but stressed their relevance as part of an integrated solution. FTRs provide the only means of mitigating the problem of preventing one party from free-riding on another party's grid investment, and also assist with signalling the need for new investment.
Two submissions (CHH and MEUG) expressed concern that the proposed FTRs would create the potential for generators to abuse their market power and profit at consumers' expense. MEUG said the Government should direct Transpower not to commence an FTR market until policy changes are first made to ensure market competitiveness, otherwise an FTR market will exacerbate the market power of suppliers. MEUG also said it was important that policies to implement enhanced use of grid and new grid investment for next winter are not affected by resources diverted to implementing FTRs.
Carter Holt Harvey would prefer a system whereby purchasers take out hedges across constraints (with a party other than the parent generator) rather than being able to purchase FTRs.

"Given the significant market power of individual generators at various times and all generators collectively most of the time in the energy market, allowing those parties to also participate in an FTR market would exacerbate their market power" - MEUG.

In its cross-submission, Transpower argued that in the long term, the solution to market power imbalances was to relieve transmission constraints and increase competition on both the supply and demand sides. Given that, FTRs would not, in the long run, have a distorting effect on market power.
Contact's cross-submission cautioned against the introduction of FTRs as a mechanism to resolve the rental allocation issue. Contact argued that FTRs may simply reallocate rentals away from the current participants to a new set of recipients.
Contact and Mark Pickup recommended that transmission rentals be rebated to lines companies' customers on the same basis as the rebates were accrued.

3.6 Retail Competition / Vertical Integration / Market Power Issues

Address Problems with Vertical Integration

It was commonly suggested that there is a need to address the market power of vertically integrated companies. The most common suggestion for improving competition was to require the separation of generation and retail.
This could be achieved by changing the SOE's Statement of Corporate Intent to require accounting ring fencing of the generation and retail businesses, to ensure that the costs, risks and financial performance of each business are separately accounted for. Benefits would include:

Improved liquidity of the hedge market;
Improved competitiveness in the contracts market;
Improved incentives for new entrants to the retail market; and
Improved retail innovation.

Predicted costs would include Commerce Commission input and possible public reaction to any upward price change to remove cross-subsidisation.
Alternatively, generation and retail could be split into separately owned corporate entities. This would have similar advantages to the option above, but with greater certainty and clarity, and would not require Commerce Commission oversight.
Disadvantages would include a requirement for legislation, separation costs and an increase in overheads. It would take a long time to implement and may create political problems for the Government and expose participants to legal, Treaty of Waitangi and other challenges.

AICon, Business NZ, Comalco, Federated Farmers, Fletcher Building, Infratil, Network Tasman, Plastics New Zealand, MEUG, Norske Skog, Mark Pickup, TrustPower, Waikato DHB

In response, Contact and Meridian argued against separation of the generation and retail arms of vertically integrated companies. They said that vertical integration provides companies with an important risk management tool. M-co also considered vertical integration to be a legitimate commercial response to managing market risk (M-co did point out, however, that this was an area requiring policy analysis by Government).

"The risks in the NZ electricity system stem from physical causes; a high degree of hydro dependence, with variable inflows and very limited storage; a long `stringy' transmission system that is prone to constraints and faces a risk of loss of major circuits; and a relatively small generation fleet with some large single units making it vulnerable to loss of major generators or ancillary equipment... Integration allows some of the risks to be `internalised' within a firm. This balancing of generation capacity and retail demand keeps the cost of risk management to a minimum" - Contact.

Meridian argued that vertical integration:

allows for greater price certainty for customers; and
provides certainty for investment in generation, transmission or in demand management options.

Grey Power's cross-submission also expressed concern about the proposed separation of vertically integrated companies because of the price stability offered by vertical integration to consumers.
Meridian argued that vertical integration does not constrain the wholesale market, saying that the extent of New Zealand's hydro variability (leading to mis-matches between generation and retail contracts) means that a proportion of generation will always be available to sell on the spot market.
M-co's submission stressed that vertical integration is a structural issue, not a market rules issue (NZEM's cross-submission also made this point). It was argued that any perceived vertical integration concerns should not be addressed by intervening in the wholesale market rules because of the lack of "quality information on whether a policy problem in fact exists," and because "intervention in the wholesale market is likely to be the least effective solution if any real problem exists."
Note that section 3.5 (Requiring mandatory hedges) includes discussion of mandatory hedges, which were suggested in the context of addressing problems with vertical integration.

Competition - Pricing Issues

Price setting in the electricity industry needs to be subject to the same rules as any other competitive industry, including the same potential for scrutiny by the Commerce Commission and penalties for anti-competitive practices (Plastics New Zealand).
Pricing methods should be developed that restrict the potential for participants to provoke conditions which lead to regional market power imbalances and to limit their ability to rent-seek if, and when, such situations arise (Robbie Morrison).

3.7 Other Market Arrangement / Design Issues

Summary of Key Points

A comprehensive review of the NZEM rules and/or the structure of the market was recommended. The importance of taking an holistic approach rather than dealing with specific problems in an ad-hoc manner was stressed.
Others argued against significant reform at this early stage of the market's existence, and said urgent matters such as the development of new generation capacity should take priority.
A review of the marginal clearing price system was recommended.
Replacement of the ex-post wholesale market with an ex-ante market was recommended.
Some suggested imposing price caps to reduce consumer price volatility. Others strongly opposed this on the grounds that price signals would be retarded.
A range of changes were recommended to the Electricity Governance Board and proposed rule book to ensure the market is able to deliver the outcomes required by the Government Policy Statement.
Submitters identified a wide range of market information which, if more readily available to market participants and the general public, could improve market efficiency, demand side management and generator bidding behaviour.

Review / Reform NZEM Rules / Electricity Market Structure

A range of submissions recommended a comprehensive review of the NZEM rules and/or the structure of the market, in order to avoid a repeat of the winter 2001 experience. Submissions stressed the importance of taking an holistic approach rather than dealing with specific problems in an ad-hoc manner.
Comalco argued that the proposed Electricity Governance Establishment Committee arrangements do not go far enough, and recommended that a comprehensive and independent review of wholesale market arrangements be undertaken, including an assessment of the approach to price setting.
MEUG and Business NZ recommended an amendment to the Government Policy Statement requiring the Electricity Governance Board to carry out a "comparative and in depth review of the New Zealand electricity market within 18 months of its (the Board's) establishment."
Pan Pac suggested that all electricity consumers should be billed via a central organisation such as M-Co at the wholesale electricity price. Advantages would include:

incentives to consumers to conserve electricity in response to wholesale electricity price rises;
potential reductions in costs for consumers by eliminating duplication in billing systems, meter reading and switching costs;
incentives for generators to offer hedge contracts to larger consumers, thereby improving liquidity in the hedge market; and
as a consequence of generator pricing being exposed to a much broader range of consumers, generator pricing behaviour would be under much greater scrutiny.

Infratil and Transpower suggested that the market design itself is not fundamentally flawed, but that further structural reform is nevertheless needed in the interests of competition, liquidity and efficient response to dry-year events. "The alternative to further structural reform is an approach of ad hoc regulatory interventions, which are in Infratil's view likely to fail and prolong the structural problems of the market" - Infratil.

Business NZ, Business Roundtable, CC93, Comalco, Energy Link, Fletcher Building, Infratil, MEUG, Robbie Morrison, Norske Skog, Pan Pac, Transpower, WEL Networks

M-co, MEUG, and Robbie Morrison pointed out the need to carefully consider a wide range of factors in developing policy options to improve the market's performance, including:

The impact of the Government Policy Statement's proposals on the market;
The implications of any climate change policy introduced in line with the Kyoto Protocol; and
The outcome of the Commerce Commission's investigation into retail acquisitions by Meridian and Genesis Power and the Commission's treatment of the proposed combined rulebook.

Several submissions argued against significant reform of the market's structure and/or rules.
WEL Networks argued that changes to the structure and processes of the market should not be made until the market has had the opportunity to gain some maturity.
Contact's cross-submission strongly opposed the idea of a comprehensive review of the market rules, believing it to be unnecessary, and because it would delay the provision of urgently needed new generation.

Suggestions about the Electricity Governance Board (EGB)

Alliant International suggested that the EGB currently under development should comprise equal representation from buyers and sellers of electricity.
Transpower, TrustPower and Fletcher Building argued that the new EGB, as currently proposed, will not be effective in improving functioning of the market - the Board, they suggested, needs more teeth. TrustPower submitted that, because any rule changes proposed by the Board will have to be passed by the members who are party to the part of the rules being changed, the EGB will lack the power to significantly improve market efficiency and address problems with, for example, generator market power. Fletcher Building argued the need for a regulatory EGB with strong rule-making powers, rather than an industry body.
TrustPower suggested that the Government should review the EGB process and the proposed rulebook in detail and consult with industry participants and consumers' representatives to ensure that the market will deliver the outcomes required in the Government Policy Statement.
Transpower also argued for a single, common and mandatory governance body to oversee market operation and future rule making in the public interest. This, they argued, would facilitate the introduction of real-time pricing and Financial Transmission Rights, further measures to improve demand side participation, and retail competition. It would also improve the industry's ability to efficiently manage dry-year risk. Transpower argued that a mandatory governance body would be preferable to the current industry proposals for self-regulation. Transpower suggested that the Government should consider legislative options for providing a workable and efficient means of ensuring that all industry participants comply with a set of mandatory market rules.
Transpower said that, where changes to the market rules are required, these should occur within a governance framework that, while able to utilise the expertise of the industry, is explicitly designed to introduce changes in the public interest. Transpower suggested that enforcing the mandatory governance arrangements and implementing the measures envisaged in the Government Policy Statement should be the primary approach to enhancing the ability of the market to manage dry-year risk.
Transpower favoured the concept of legislative enforcement of the market governance arrangements, though it recognised the potential risks of implementing a regime that is not responsive to technological and other changes, and which fails to draw on the expertise of the industry. Other costs would arise from an increased level of administration.
Transpower argued that the benefits would include:

More rapid development of improved means of demand side responsiveness;
Assurance of effective processes for efficient multi-lateral decision-making;
An informed and independent source of ongoing advice to the Government on the progress of the industry;
Any consequential improvements to industry efficiency that would accrue from policy or regulatory changes based on this advice;
Savings from any avoided delay in the establishment of an effective EGB;
Savings in compliance and enforcement costs; and
Providing certainty required for industry, consumer and investor confidence.

The Consumer Coalition on Energy (CC93) said that, whatever policy changes the Government decides on, it is essential that an effective and unbiased means of implementing those policies is chosen. CC93 said the Electricity Governance Establishment Committee and EGB were both unlikely to take sufficient account of consumers' interests.

"CC93 would object to any policy implementation being delegated to the Electricity Governance Establishment Committee or being held over for the EGB to act upon. The Electricity Governance Establishment Committee has proven to have the same flaws as NZEM by entrenching supply side biased solutions because the supply side dominates the decision making processes. The EGB may have independent directors but the rule making and rule changing process will continue to be in the hands of the four major generators" - CC93.

Market Information (General)

Submitters identified a range of areas where better access to information for market participants and the general public would improve market efficiency, demand side management and generator bidding behaviour.
Information should be readily available (e.g. through the internet) and, if intended for public consumption, needs to be in a form appropriate for this purpose, rather than being highly technical. If software programmes and market tools are needed in order to analyse the data then these should also be made readily available.
Specific areas where more information was said to be needed included:

historic and day-to-day NIWA inflow and hydrology data;
information on the state of national fuel resources (e.g. through undertaking and publishing an external review of hydrology and other fuels);
storage, inflow, production and forward price estimates from generators (including data on generators' hydrology management and supply strategies);
historic load flow and price data;
details of hydro spill;
generator offers and purchaser bids into the NZEM (some suggested these should be disclosed within 24 hours, others suggested one or three months);
wholesale dispatch information;
primary hedge information, including future prices (e.g. generators could be required to disclose hedge contracts they have entered into);
spot prices and their derivation;
retail contract pricing;
details of line and energy charges (these should be clearly explained in electricity accounts to allow consumers to distinguish the best deals); and
financial statements of integrated generator/retailer companies, in particular the details of internal hedge contracts.

AICon noted that there is no provision for an overview of generation capacity and supply capability across the market as a whole. The move to have better, more freely available short and medium term projections of system adequacy (as per the Government Policy Statement) was supported.
The Health Sector EBG expressed support for the Government Policy Statement's intent to achieve the public release of wholesale market information after three months, and to provide forward price information based on aggregate information on hedge prices.

"Improving the availability of information should help to ensure that parties make more informed decisions in the future and should as a consequence increase the demand for risk management products" - Meridian.

"[Making] all NIWA historic and day-to-day hydrology information available on a public website... would allow greater demand side awareness and in turn lead to earlier and better demand side management... Greater transparency in pricing decisions to reflect the costs associated with generation, cost of transmission, and finally, retail margin [would help to avoid] opportunistic behaviour on the part of both lines companies and generators" - Federated Farmers.

"EECA and other non-market participants should have access, at no cost, to market information that enables it to monitor `market conditions', including lake levels, inflows and market prices" - EECA.

The Consumer Coalition on Energy said that consumers should receive detailed information on the key components of their power bills. Both households and small-medium businesses would benefit from having the major charge components detailed on invoices, so that these can be monitored and challenged.
Comalco recommended, in order to "restore confidence in the NZEM" following winter 2001, a one-off disclosure of generator receipts from the NZEM from January to September 2001, and ongoing disclosure of all NZEM generator offers and re-offers from January 2001 forward.

AICon, Business NZ, CC93, Comalco, Contact, EECA, Federated Farmers, Fletcher Building, Grey Power, Health Sector EBG, Meridian, MEUG, Mighty River Power, Robbie Morrison, Natural Gas Corporation, Network Tasman, NIWA, Orion, Pan Pac, Brian Tolley, Transpower, WEL Networks

In its cross-submission, NZEM expressed support for enhancing the transparency of the market through the disclosure of relevant information, provided the release of information was consistent with the provisions of the Commerce Act, and did not undermine the ability of market participants to act competitively (Meridian's cross-submission expressed similar sentiments).
Contact's cross-submission expressed concern about increasing the transparency of hedges by identifying deals - this, it suggested, is the equivalent of exposing any financial transaction that impacts on profitability and may reduce a company's competitive position.
Further, Contact suggested the release of hedge prices would be of little practical benefit because the majority of hedges are written to reflect customers' specific requirements.
Contact also queried the assumption that disclosure of hedge prices would lead to more hedges being available at prices that suit purchasers.
Contact suggested that encouraging greater use of the futures contract market would be more useful than requiring the release of hedge prices.
NZEM pointed out that its Rules Committee is currently pursuing options to improve the availability of information to the public.
In addition, NZEM and Transpower noted that the Government Policy Statement contains many references to the desire to make information available, including offers by generators, information relating to hydro-spill, and forward price information.

Climate Information (Specific)

NIWA made several recommendations regarding the need for better availability of hydrology information:

an independent review of hydrology/climatology over winter 2001, focusing on climate variability due to cyclic processes, and the long term effects of climate change;
a review of the existing market hydrological information system provided through M-Co with a view to making it more accessible and comprehensive; and
NIWA could extend its services to provide a monthly or seasonal service for the electricity industry, which would benefit energy efficiency projects (demand side) as well as generators. If all market participants had access to information on hydrology and climatology risks, this would facilitate more informed supply and demand decisions.

Review the Marginal Clearing Price System

Consider rewarding generators with their cleared bid price instead. This may encourage generators to bid closer to true marginal costs and reduce excess returns in dry years (Network Tasman).
If generators were only paid their offer price, the average wholesale electricity price would be lower (although not significantly lower than the price set by the current formula) and would certainly be less volatile (Pan Pac).
AICon suggested that the marginal clearing price system should remain, and should not be changed simply in order to address problems with lack of competition.
Contact and NZEM argued in favour of the marginal clearing price system, and said the alternative, using the average price, would be economically inefficient. NZEM said that average pricing would tend to result in more output being produced than is efficient. (Refer to section 2.7 - Marginal vs. average cost pricing - for a wider discussion of this issue.)

Establish an Ex-Ante Wholesale Market

The ex-post market should be replaced by an ex-ante wholesale market, with trades achieved prior to dispatch to allow demand side reductions to be achieved (Alliant International, Brian Tolley).
Wholesale prices should be set 4-24 hours in advance to ensure that price signals can provide for workable demand side management (Fletcher Building).
In its cross-submission, Contact argued that the adoption of an ex-ante market prior to winter 2001 would not have significantly changed the outcome for the industry as a whole.

Cap Prices

In response to the high spot prices seen in winter 2001, three submissions argued that price caps should be imposed on the market, either during "crisis" conditions or as a matter of course (Grey Power, David Renouf, CHH).
CHH argued that, if generators' spot market offers were capped at a certain level then those generators not prepared to offer at that level should not offer at all. The resulting supply shortage would serve to send a signal to end consumers to conserve.
Other submissions, however, strongly opposed the idea of price caps because this would reduce the impact of price signals on both sides of the market.
NZEM's cross-submission explained that a price cap would run counter to the efficient use of resources, and could lead to a real risk that generation capacity would not be available when needed.

"... a price cap would dampen the signal for retailers to negotiate with customers, or to introduce tariffs to incentivise customers to save power in these types of unusual circumstances. Secondly, it would remove the longer-term incentive for customers to contract with private sector and SOE generators. More critically, the prices in contracts would be lower that they should be and the market would inevitably fail to invest in the new [generating] capacity necessary to ensure that, despite growing loads, future dry year events can be adequately managed" - Infratil.

AICon, Business NZ, Business Roundtable, Federated Farmers, Infratil, Meridian, NZEM

Contact's cross-submission said that any move to cap spot prices needs to be considered with great care, lest price caps destroy the incentives to maintain reserve plant.

3.8 Ownership Issues

Federated Farmers and Infratil recommended that the Government should divest its retail businesses (given that this market does not involve ownership of strategic national assets) and also its generation assets (to minimise the potential for political interference and encourage new investors to enter the market).
The Business Roundtable stressed that options for increasing competition through reductions in state control of the industry must be considered.
In contrast, Grey Power's cross-submission argued that SOE generators should be removed from the SOE Act and converted into Crown Owned Companies, with the primary responsibility of providing lower electricity prices rather than profits (in the interests of the public).
MEUG's cross-submission suggested the SOE suppliers could publish quarterly reports like private and listed companies, to better mimic the market disciplines of private and listed companies.
Refer to section 3.6 (Addressing problems with vertical integration) for further discussion on ownership issues.

3.9 Contingency Planning / Establishing "Triggers"

A range of submitters said there is a need to develop contingency plans to deal with extreme circumstances. Planning for events such as cold, dry winters would help reduce the time it takes suppliers and consumers to respond.
Contact and Transpower said areas where contingency planning would be valuable included:

temporary changes to grid configuration to relieve transmission constraints;
interruptible contracts with large and medium-sized customers to allow generators to buy back some of the power they had contracted to supply;
retail consumer campaigns; and
setting triggers for Government intervention in the market, if necessary.

Early warning flags or triggers should be developed to signal impending shortages/dry year conditions. The industry could then go into an agreed crisis mode in timely manner (Network Tasman, Transpower).
Establishing procedures for implementing future conservation campaigns would result in a more prompt response by conservation authorities and reduce delays in achieving savings. Advance preparation of "off the shelf" conservation campaigns for retailers should also be promoted (Energy Management Assn., EECA, Contact).
The Government should request the Ministry of Economic Development and EECA to prepare a basis for charging generators for any future costs of Government or EECA intervention required to appeal to the public's goodwill to save energy (MEUG).

¹The Government Policy Statement, issued in December 2000, made it clear that the New Zealand system is inherently volatile and subject to dry year risk, that it was up to market participants to protect themselves against these risks, and that the Government was not expected to step in and protect those who had not protected themselves.

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Printed: 26/11/2009