7. Why Will the Electricity Market Be Improved After the Split?
To assess the effects of the split in detail, ERTU built a model of the electricity market which includes the individual generating companies. The commercial incentives on those generating companies before and after the ECNZ split have been examined using this model under a variety of different scenarios. This has allowed ERTU to assess the likely impacts of the ECNZ split. In making this assessment, ERTU has assumed that the market participants will be experienced entities operating largely in a rational and prudent manner. ERTU's views of the likely impact of the split are summarised below.
(a) More Competitive Behaviour
As a large generator, ECNZ has significant ability to influence prices. It also has much greater commercial incentives to support prices at higher levels than any of the three new SOEs will have.
By temporarily withdrawing some of its capacity from the market, ECNZ is able to raise prices and benefit from extra revenue from the balance of its generation. It could, for example, support higher prices by withholding hydro capacity or Huntly capacity from the market. Thus, currently ECNZ has commercial incentives to allow its competitors to generate more than would occur in a fully competitive market, while improving its overall profitability.
In contrast, each of the new smaller SOEs would need to withdraw a much larger proportion of their capacity from the market, to achieve the same effect on price as ECNZ is able to achieve. In attempting to do so, the new SOEs would be placing much larger proportions of their generation, and therefore revenue, at risk to competitors. Further, each of the new SOEs will have less ability to influence prices because of their size and the nature of their assets.
To accommodate other generators is a rational commercial response for a large portfolio generator like ECNZ. Splitting ECNZ will create a much more competitive market where the Huntly company will have stronger incentives to compete with less efficient non ECNZ generation (such as New Plymouth). Also in this more competitive market the hydro generators will have reduced incentives to hold prices up by spilling water.
(b) Better Quality Information on State of Electricity Market
With more generating competitors and a more competitive retail market, there will be a greater range of views of future electricity supply and demand reflected in market prices. This will lead to better price signals over time and more effective risk management by market participants.
During the 1992 hydro drought, for example, the risks of impending electricity shortages were not adequately understood by most electricity retailers because of the lack of market information and because price signals at the time reflected only ECNZ's internal view of the likely risks to supply.
Since Contact Energy and the wholesale market were established in 1996 the extent of information available to electricity retailers to assess risk has improved significantly.
After the split the smaller SOEs will be less able to manage risks internally and will need to contract explicitly with third parties to mitigate their commercial risks. This will increase market knowledge of underlying risks and lead to more transparent management of uncertainty.
(c) Greater Customer Choice
In parallel with the split, the development of genuine retail competition will lead to customers receiving better quality service from retailers. Whether selling direct to electricity users or to electricity retailers, generators will have stronger incentives to compete for and retain customers. That will be reflected in the way generating companies manage customer relationships, power station reliability, fuel supply availability and levels of hydro storage.
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