Electricity in limbo

More than two-thirds of our generation capacity - and retail businesses serving a roughly equivalent proportion of retail customers - is owned by the New Zealand Government through three state-owned-enterprises. Most of the remainder sits in the two private listed companies, Contact and Trustpower.

This structure was originally set up with the break-up of ECNZ and the privatisation of Contact in 1998. It has essentially remained unchanged since.

Corporatised state ownership is a common model adopted as a transitional arrangement by governments restructuring electricity markets. Restructuring and the facilitation of private participation has a range of objectives, but generally includes using competition to reduce prices to consumers, and relieving Government of the cost burden of providing new capacity.

The entire England and Wales electricity industry was privatised in 1990, while the USA’s has always been completely privately owned. In Australia, Victoria privatised its electricity industry soon after Britain in the early 1990’s, and South Australia followed suit a few years later. Western Australia and Queensland are progressing with independent power producer (“IPP”) programmes, while New South Wales is in the process of opening the door to limited privatisation in the electricity sector.

The UK provides an interesting case study, and was a model that New Zealand partly adopted, at least in the initial phases. The UK Government first set up a wholesale electricity trading market and two competing generators: Powergen and National Power. After the market was operating the two generators were privatised with the operating risk transferring to private investors. This left the UK Government free to regulate and shape the market to achieve its objectives. Interestingly, two generators proved insufficient for an effective market and the Government forced the sale of a proportion of capacity from each of the incumbents in order to create greater competition.

The initial New Zealand privatisation programme involved the passing of the Electricity Reform act in 1998 and the privatisation of Contact Energy when 40 percent of the company was sold to cornerstone investor Edison Mission, with the rest going to New Zealand investors.

The Act saw the creation of three new competing SOE’s out of what was the Electricity Commission of New Zealand (ECNZ). Four generation companies soon became five when Trustpower sold its distribution assets, and this quintet was now competing in the wholesale market. So far so good, and although no process was ever initiated, the intention was fairly clear: Sell down the new SOEs into private ownership. However, the election of a Labour Government in 1999 brought these plans to an abrupt end, and privatisation of the generators went no further.

It is difficult to believe that the current model was ever intended to be the long term structure for the sector. Three Government-owned companies competing with each other and with private, investor-owned companies makes little sense. If the SOEs compete vigorously, it is at best a ‘nil sum’ game for their Government owners. At worst, it reduces their collective value if they prove less effective competitors than their private sector counterparts.

A key objective of the New Zealand Government reforms of 1998 was to introduce competition into electricity supply but, beyond that, the goals were not entirely clear. Given the local regime initially echoed the privatisation of the English and Welsh system, it is interesting to consider the objectives this had – essentially to introduce competition and, through that, reduce prices to consumers.

The knock-on effects were to make the UK companies more efficient and eliminate the tendency of Government to over build capacity and create substantial surplus plant. It also resulted in the construction of much more efficient gas plant and the retirement of a good deal of old coal plant.

Arguably our model has delivered the worst of both worlds. Prices to consumers have risen substantially, and we have had three national power shortages since 2000. With capacity short and prices high, you would expect the SOEs to be generating substantial returns. A recent parliamentary report on rates of return indicates that this is not the case. The companies are mostly returning less than the Government’s cost of capital (as indicated by its bond rate) - well below what could be considered reasonable given the industry risk to which they are exposed.

Not only do consumers appear to be being poorly served, but the taxpayer is receiving an inadequate return on the capital it has invested.

The evidence suggests that there are some substantial problems with the current ownership model in our electricity industry. At least in part, this can be traced back to an ownership structure which has been stuck half way between a private and public model for almost a decade. Government’s future objectives for the sector remain foggy, but further structural reform is clearly needed.

The introduction of private capital, if done well, I think, could contribute to a substantial improvement. Private ownership brings with it financial and commercial disciplines that are difficult to truly replicate under publish ownership. It releases capital for Government, and removes the inherent conflict faced by Government as both owner and regulator of the sector. The to-ing and fro-ing over the emissions trading scheme being is a case in point with the potential to create substantial transfers in value across the Government’s portfolio and between public and private sectors.

Private ownership does not necessarily mean ‘full privatisation’. One option is a partial sell-down of its ownership through a public float while retaining a controlling interest. If a meaningful interest is sold down, this has the potential to invigorate capital markets and provide valuable transparency of how and where the companies are creating value for their public and private owners. It would also apply a consistent set of measures across participants and make comparisons of performance more meaningful than at present. In reality, this is not a huge step from where we are now. The model already applies to Air New Zealand, albeit with very low liquidity of non-state holding, and some of the SOEs have issued publicly traded debt instruments.

After a decade stuck in what was originally intended to be a transitional arrangement, it’s high time we focussed on what we are trying to achieve in the sector and what is the appropriate ownership structure to deliver it.

As published in the Energy NZ's Spring 2009 edition.