Thursday, November 5, 2009

Different viewpoint

Brian Leyland has long been seen as the independent commentator of the electricity industry. Mr Leyland often has quite different views to most in the industry and gets some traction from his seeming common sense. To an extent Mr Leyland does bring a common sense alternative view. To an extent, however, his comments can overlook some inconvenient realities.

The most recent example of Mr Leyland's views that I have read is available on

http://www.nzcpr.com/guest170.htm

There are a few problems with the view given by Mr Leyland in this opinion piece. The piece is described as shedding light on the rising cost of power but some of the light being shone is pretty dim. As such it is worth shedding a bit more light on Mr Leyland's own commentary.

Mr Leyland selectively uses aspects of the original decision process about the New Zealand Electricity Market to suggest that a single buyer option would have been better. He describes the single buyer option as being considered lower risk (and therefore better?). It is important to note here that low risk was compared to what was deemed to be the current practice. In this context it is easy to see why a single buyer model might have been considered low risk. The status quo was a centrally planned network where engineers took all care but no responsibility, and either taxpayers or electricity purchasers pay for their mistakes. The single buyer model allows the network to be centrally planned by engineers who take all care but no responsibility, and either taxpayers or electricity purchasers would pay for their mistakes. Pretty low risk; for the engineers.

The bid based auction model that was implemented was designed entirely so that it would be private capital that took the risk. Arguably this has been watered down by maintaining much of the generating assets under government ownership but this doesn't seem to be the case. Even under the SOE model it is clear who is responsible for the use of money.

No doubt Mr Leyland would argue that the centrally planned network was better. The evidence is not kind to this point of view, however. While the dry years of the 2000s are in recent memory (and there had been a great deal of publicity and calls for voluntary savings) the country didn't run out of energy. If one looks back through history it will be found that energy rationing was very common under central planning, although the economy was very different then as well.

Under central planning New Zealand also had a history of building bad projects. Most went over time and over budget and many had significant engineering problems. I would challenge Mr Leyland to argue that projects under the electricity market have been as poorly managed as occurred previously. Mr Leyland would no doubt point out that potential shortages over the 2000s indicate how badly the market performs. I could easily make a strong argument that it was regulatory uncertainty during the 1990s that lead to the outcome that none of the restructured industry players of 1999 had workeable projects in the pipeline (which coincided with far longer development timetables than central planners ever had). Looking forward from today, each generator has many potential generation projects. Now that the development pipelines have been filled security of supply looks like less and less of an issue (although hydro dependency will always mean some risk).

Mr Leyland's comments on the Vickery auction make it sound like this is a mechanism designed to rip people off. In fact the auction methods used to overlay on industries where there traditionally haven't been markets are designed to replicate exactly how people behave in markets. They are abstractions, but they are intended to mimic how people trade not replace these methods. Now, I will agree with Mr Leyland, to an extent, that the industry can get carried away with its abstractions, and sometimes forgets the fundamentals, but this also happens under central planning. The justification usually given under central planning for errors of judgement is that people should have behaved the way that they should have done.

At the end of the day, though, the arguments that Mr Leyland uses for pricing problems are all static. Essentially Mr Leyland's arguments are that you could design a pricing methodology for electricity that would make it much cheaper now. In this he is right but this is not what the electricity market is designed for. The electricity market is designed for what is known as dynamic efficiency. This means that the intention of the electricity market design is to enable the most efficient investment in electricity generation and transmission, ie for the lowest electricity prices over time.

In other words the electricity market has a highest current price design based on generation projects that are relatively inexpensive and delivered on time, on spec and on budget. Mr Leyland's suggestion is, history suggests, priced 'fairly' (fairness will also be determined by the central planner) to allocate the cost of projects of impressive feats of costly engineering delivered over time, over budget, and usually with significant problems. His suggestion sounds attractive but actually costs everyone a lot more.

Now, let's be very clear. The reason that electricity costs keep rising is because we keep using more. As any country consumes more and more energy it gets harder and harder to supply. In this context harder means costlier. We have literally burned through one of our greatest energy resources (the Maui gas field) quite rapidly (we exported about a third of it) and now it gets harder and more expensive.

10 comments:

  1. He describes the single buyer option as being considered lower risk (and therefore better?).>>Not me. According to the then Secretary of Energy, WEMDG was told it was lower risk cf the alternative. As the Vickery auction was venturing into unknown territory, this could/should have been taken into account.

    It is important to note here that low risk was compared to what was deemed to be the current practice.>>>NO! It was compared to the alternative they were offered.

    And so on..

    I have made a comprehensive response but this limits me to 4096 chars. bryanleyland@mac.com

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  2. My apologies on point 1. It clearly was the then Secretary of Energy that made the comment.

    In regards to point 2. I agree, I obviously wasn't clear. The point is that it was thought to be risky becasue it was very different to the existing proposal whereas a central buyer type model was not.

    If the same assessment was done today it would not be described as risky because it has been tried.

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