4. Competition Assessment
4.1 Introduction
ERTU has been asked to consider whether or not each of the three new SOEs will be effective competitors. ERTU has undertaken this assessment within the assumptions set out in Section 1, and the assumption that market participants will generally behave rationally. ERTU considers that an assessment of whether an alternative market structure would achieve a better outcome is outside its terms of reference.
However, ERTU has assessed the likelihood of any changes in the wholesale electricity market as a consequence of retail reforms and considers that there will continue to be some form of spot market where generators compete to be dispatched, and that spot prices will continue to be set in a similar way to now. Because effective retail competition will occur as a result of lines and energy separation, and barriers to entry will be comparatively low, retail and wholesale prices are expected to track each other closely over time notwithstanding short term spot price volatility.
ERTU's view is that the competition objectives will have been achieved if:
- prices are more responsive to changes in supply and demand conditions than in the status quo (with ECNZ intact);
- each new SOE is able to compete in the wholesale electricity market;
- none of the three new SOEs (or Contact Energy) is in a dominant position such that it is able to set prices without significant constraint by competitor reaction; and
- the mean pricing outcomes are expected to be significantly (at least 10%) lower than in the status quo (with ECNZ intact) throughout the period of expected surplus capacity over the next five years.
4.2 Approach to Assessing Competition
In assessing the competition impacts of splitting ECNZ, there are three relevant markets to consider: the short term (or physical spot) market, the wholesale contracts market and the market for new investment. ERTU has also considered the retail market in light of current reforms and generator entry into retail. However, as noted above, ERTU believes that retail and wholesale prices will on average track each other and competition assessment in the wholesale market is the appropriate test to apply.
Moreover, ERTU considers that the focus for competition is the physical spot market in which generators compete for short term dispatch. The wholesale contracts market tends to mirror medium term expectations for spot prices and will tend to be dominated by the effects of competition in the physical spot market. Because the contracts market is largely dominated by financial hedge contracts, it is intrinsically more competitive with a number of sellers and buyers participating. The market for new investment tends to hinge around long term expectations of spot and wholesale contract prices. It, too, is intrinsically more competitive since all existing players and new entrants will compete to provide new capacity.
Therefore, while the three new SOEs will compete in their usual course of business in the physical spot, wholesale contracts, retail and new investment markets, ERTU has focused its assessment on the physical spot market.
In considering the physical spot market, ERTU approached the question of whether or not each of the three new SOEs will be effective competitors by considering each SOE's incentives to compete and the overall spot market outcomes relative to the status quo.
This was achieved by developing a model of the New Zealand Electricity Market and a base case scenario against which to evaluate likely market behaviours. The market model was used to simulate pricing offer strategies for the three new SOEs, and other significant generators including Contact Energy.
By measuring "net revenue at risk" for each generator it was possible to evaluate alternative offer strategies and determine likely market behaviour for each SOE and likely market outcomes. Using this technique, ERTU examined whether any of the SOEs would be able to set prices to any significant degree, whether prices were likely to be more responsive to supply and demand conditions, and likely overall pricing outcomes.
4.3 Sensitivity Analysis
ERTU also developed a range of possible market scenarios. These include low demand growth, dry years, wet years and sustained price wars. Likely market behaviour was evaluated in all these cases as well as the base case.
4.4 Conclusion on Competition
ERTU's final opinion is that the competition objectives will be met and accordingly that:
- prices will be more responsive to supply and demand variations, with the split of ECNZ into three new SOEs;
- each new SOE will be able to compete in the wholesale electricity market;
- none of the new SOEs will be dominant in the market and each new SOE will have incentives to compete; and
- mean pricing outcomes in the wholesale market are expected to comfortably exceed the 10% benchmark throughout the next 5 years.
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