Monday, December 21, 2009

Response from Bryan Leyland

Following the post
Mr Leyland has asked that he could have a full response published.

The following comes from Mr Leyland unedited (although the formatting didn't copy properly and so I have tried to correct that only). The following material does not represent the opinion of the Headitor.

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.

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. Which is exactly what happens with the current market. (Except that the engineers are replaced by energy traders out to make a quick buck.) The electricity purchasers pay. The ex ECNZ hydro and geothermal stations make obscene profits.

The bid based auction model that was implemented was designed entirely so that it would be private capital that took the risk. Might have been designed that way, but it didn't happen.

No doubt Mr Leyland would argue that the centrally planned network was better. I was never a supporter of the MoW/NZED monopoly.

If one looks back through history it will be found that energy rationing was very common under central planning.
Yes, in spite of the NZED/MoW going flat out building new stations. But political interference was a major factor - and it still is. Read the GPS!

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.
Yes. Mostly political. Clyde is a classic example. Otahuhu and TCC stations have not been trouble free and are still a major risk because the boilers are seriously dodgy. They got exactly what they paid for - a cheap station not designed to work reliably in the NZ system.

I would challenge Mr Leyland to argue that projects under the electricity market have been as poorly managed as occurred previously. See above. I AM NOT suggesting a return to the politically dominated NZED style central planning.

Mr Leyland would no doubt point out that potential shortages over the 2000s indicate how badly the market performs.
Yes. Especially the 2008 shortage when the lakes were very low in the late summer. This major factor was conveniently ignored by the "review". See my submission on it.

Looking forward from today, each generator has many potential generation projects.
What are they? How many will get built? We now know that wind power is very expensive indeed and contributes least when it is needed most. Many of the new projects are wind. According to my information, there is one geothermal station of about 130 MW coming on line next year. For the next two years after that, there might be one of 60 MW windfarm which will make very little difference. There is a lot of talk about more generation, but no commitment. Time is running short.

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).
We will see. Quite soon, I suspect!

Mr Leyland's comments on the Vickery auction make it sound like this is a mechanism designed to rip people off.
Yes. Try reading Mcdiarmid. (It is on my website) "A Modest Proposal: Revoke the Nobel Prize? Recognize the Limitations of Theory? Or Grant a License to Steal?" Using a California-style second-price auction structure in a highly volatile market with a limited number of bidders is close to a license to steal when the market approaches a peak and concerted action is highly rewarded.

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.
Fine. But, sadly, kWh is not a market commodity in terms that Adam Smith would understand. Little price elasticity and no alternative good.

… the industry can get carried away with its abstractions, and sometimes forgets the fundamentals, but this also happens under central planning. I am not talking about central planning as it was under the NZED. Central coordination is a better description of a single buyer. The single buyer goes to competitive tender for generating capacity. He does not decide which specific power stations must be built. This is a very important difference!

The justification usually given under central planning for errors of judgement is that people should have behaved the way that they should have done. Aren't the current set of fiddles to the market justified on exactly that basis? A pious hope that if the deck chairs are re-arranged, the ship won't continue to sink?

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. You can put a ring around that!

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. Which it has signally failed to deliver!

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.
??? Otahuhu B was late and has inherent boiler problems (Google "P91 steel HRSG"), Te Apiti has had major gearbox problems, Makara is VERY expensive, the new Taranaki open cycle GT is rumored to have problems and so on. But now, it is all "commercially sensitive" so we don't hear about it.

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. No. By making this statement the writer demonstrates that he he doesn't understand the difference between a single buyer and the MoW/NZED + political interference.

His suggestion sounds attractive but actually costs everyone a lot more. Prove it! If we continued to get 60% of our power from low cost, fully depreciated hydro stations that the consumer paid 40% of the cost of, even fabulously expensive new stations would not jack the prices up to what we have seen - and will continue to see.

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. I don't agree. In fact, in real terms, I suspect it gets cheaper. Simply using modern roller compacted concrete instead of mass concrete for a hydro dam knocks about 40% off the total cost. A modern CCGT is far cheaper and far more efficient than gas fired steam. Geothermnal is getting cheaper as drilling technology advances and wet steam turbines get to be more efficient. Our power is more expensive because the market rewards generators for keeping us on the edge of a shortage and provides windfall profits to existing generators. Confirmed by Barrett and Turner in their farewell speeches.


  1. I only have two points/questions (at this stage).

    You are quite correct in regards to my failure to understand the subtlety of your central buyer model. The difference between central planning and central coordination seems to me to be mainly semantic.

    You have mentioned political intereference a lot and I agree this has always been a big problem (and probably always will be). In this context by political interference I mean poorly thought out interference for political reasons as opposed to good governance. But isn't a central buyer model going to be far more susceptible to political interference than a market model?