A Submission to the ACCC Review of the Electricity Price Cap,
24 July 2000
SUMMARY
In addressing the matters in this application, we make only a short submission, which covers general analytical issues. However we also append a paper, Marginal Costs and Prices in the Electricity Industry we have authored. The paper addresses broader issues than those immediately before the Commission, namely that longer term prices, aside from during particular periods of shortage or glut, must reflect total and not just marginal costs.
The paper describes how this process operates just as effectively in a market based on auction prices as it does in the myriad of other markets which constitute the economy. And it demonstrates how intervention to prevent this market based process from operating will undermine its efficiency and ultimately bring increased prices.
The specific issue before the Commission is best addressed within the framework of "why should there be a price cap" not one of whether it should be set at one level or another. Affordability of electricity is sometimes given as a reason for placing a cap on the price at which it may be traded. Whilst governments may wish to address this matter, it is not an appropriate consideration for the Commission which seeks to ensure consumer benefits are derived from competitive markets.
The only two relevant reasons for maintaining a cap are that:
- market supply is highly distorted and the cap's removal will lead to price gouging;
- efficiency best pursued by allowing the cap's removal to be phased-in so that there is a transition to a more complete marketplace.
The NECA proposals address these two issues by recommending a move to a higher cap (implicitly on the basis that there has not been significant market abuse under the existing cap) and a phase-in of the increase.
In reviewing these issues, it is difficult to envisage that the ACCC will bring any superior wisdom to bear on the details of the matter than NECA operating within the ACCC authorised Code framework. Indeed, this is consistent with the position the Commission took in its December 1997 Determination when it said, "Although the current value of VoLL is arbitrary the Commission is not in a position to recommend the appropriate level. Instead the Commission accepts the current level of $5,000."
This however indicates a need for more general reform. As was pointed out by a number of participants at the conference of 18 July 2000, this particular issue has had a long gestation having been addressed by regulatory agencies for over two years. The re-trial of each case against the same criteria causes unnecessary delay and cost. In the immediate situation it is preferable that the ACCC confine its review to issues of verifying that a fair procedure was followed and that the outcome does not conflict with competition policy. In the longer term it may be appropriate to amalgamate the ACCC and NECA processes.
THE APPLICATION
NECA's Reliability Panel has sought to
- raise the price cap (VoLL) from its current level of $5,000 per MWh to $20,000 over a three year phase-in period
- at the same time impose a cumulative cap equivalent to $1,786 per MWh
- introduce an annual review of VoLL.
ADDRESSING THE ISSUES
OVERALL CONSIDERATIONS
The objective of the National Electricity market rules is to ensure we obtain the lowest sustainable price for electricity. Competitive markets are the only means of achieving these goals with any certainty. Interventions to force lower prices than the cost reflective prices that emerge from market processes will distort investment decisions and result in higher overall prices.
These conclusions may not prevail under two contingencies: market failure and the unwinding of an existing regulatory arrangement.
MARKET FAILURE
Market failure is a highly misused rationale for regulatory intervention. It is sometimes used to define any outcome that does not conform to that which has been expected. In fact market failure occurs in specific circumstances that, in practice, are almost exclusively associated with market power or monopoly situations.
The issues of market power in electricity markets are more pervasive than in almost any other market. Electricity's non-storability, a short term demand that is unresponsive to price and relatively few possible supply augmentaions at particular times can lead to potentially frequent occurrences of market power. This is one reason why markets for electricity have been more highly formalised than those for other commodities. But there is nothing illegal about "gaming". Under the Trade Practices Act a firm is not denied the liberty to reduce its supply to the market for whatever reason and under the Code the supplier may simply be asked to explain the reasons for a sudden change in its market offerings.
It has been pointed out that the Californian Public Utilities Commission has set a price cap of US$750 and has investigated a number of high price excursions. California (like the UK) has a capacity payment approach in contrast to Australia's energy only market. Arguably, this invites market failure and a consequent need for more aggressive policing on the part of the market controller.
But a potential for monopolistic abuse is seldom best combatted by price restraint. Indeed such restraint is likely to exacerbate the adverse outcomes of such abuse by restraining new supplies. This is evidenced by the February 2000 intervention into the market by the Victorian Government in response to power failures. The lower prices that the intervention created are the opposite of the incentives the market requires. Such outcomes are sought to be combatted in the present application by ensuring that an investment driver of high prices is maintained.
Much of the framework for current concerns stems from the experience of the England and Wales market where the restructuring of supply into two dominant groups led to prices that were in excess of those considered to be reflective of costs. It should be noted that the monopoly power in that market has eventually been suppressed by the attraction of new capacity, though few would deny that a superior solution would have entailed disaggregating the industry into more suppliers in the first instance.
Australian concerns are that the continued de facto market separation, for at least some of the time in the southern and eastern states, has resulted in four markets where suppliers have the opportunity to exercise market power. Even if this were the case it would still not justify intervention by regulatory authorities. Such regulation would only be justified if those authorities could arrive at a superior outcome than that prevailing with distortion. And indeed, the UK outcome, flawed though it is, remains far superior to the centralised structure it replaced.
In point of fact occurrences of monopolistic ramping up of prices in the Australian market are rare and perhaps non-existent. This is notwithstanding that in the case of NSW, Queensland and South Australia the structure of the supply industry is such that some generators potentially have market power.
In the case of NSW, the relatively robust interconnect with Victoria makes the exercise of this market power difficult. In its overall outcome, the price level in NSW has been characteristic of a supply glut rather than market power -- by any criteria prices have been well below the costs of supply. Future occasions when market power is exercised of are possible and it would be preferable for the NSW to further disaggregate its generation businesses. Any future ability by NSW generators to exercise market power will, however, be further tempered as a result of transmission developments linking the state to Queensland. That said, modelling work by ABARE (1) has suggested that NSW generators could have market power even in spite of the main QNI link.
As in NSW, the Queensland Government decided to maintain generation portfolios which may have allowed the exercise of market power. However two issues need to be born in mind prior to a rush to judgement in favour of regulation. First, Queensland had a tight supply situation stemming from the failure of governments to undertake adequate levels of investment in recent years. Second, the high price situation is in the process of curing itself with a vast increase in new generation and an increase in transmission links. One of these transmission links is a world first entrepreneurial link made possible by the provisions of the Code. In the near future a glut of electricity in Queensland is anticipated and its export into NSW will provide further discipline on prices in that state.
In the case of South Australia, the possibility of arranging for increased numbers of competitors was limited. Already one third of the State's power is imported and the bulk of the remainder comes from two plants with different cost characteristics. However, high prices have stimulated increased investment both in plant capacity and in transmission links. The latter are, like one of those between NSW and Queensland, entrepreneurial and do not require regulators to place a tax on consumers. The entrepreneurial transmission links place this form of supply on a more level playing field with generation and avoid distortions which are the inevitable corollary of regulatory decision making.
The foregoing indicates that, while improved structures are preferable as means of ensuring markets operate to the maximum benefit of consumers, as long as there is open access and regulatory approvals for new facilities are readily granted, markets are a potent force in delivering efficient outcomes. In the end these transfer benefits to the consumer.
Part and parcel with the price stimulus that the above addresses, is the need for high needle peak prices. It appears that the community's toleration of power failures and brown outs is being reduced. In part this is due to the greater need for constant power due to modern electronics.
A higher requirement for reliability may mean a greater need for peak plant that will seldom operate and hence require high remuneration when it does. Such plant could be made available by an entrepreneur bidding into the market only when the price is very high. But more likely it will be provided contractually, rather like the Reserve Trader but contracted voluntarily by retailers and others who wish to avoid exposure to very high prices. Voluntary transactions between participants in markets are the best insurance against suppliers (or customers) seeking to manipulate prices in periods when they have market power.
THE TIMING OF AN INCREASE IN THE PRICE CEILING
With regard to the timing of the increase, the NECA proposals involve a phase-in and some submissions have sought a further delay. The case for this rests on the contracting period and the market response.
CitiPower maintained that a slightly longer phase in be adopted in view of the contracting periods and lead times. These are legitimate issues, which call for judgements and, we maintain, the ACCC is in no position to argue that the timing proposed by CitiPower is preferable to that of NECA.
ENDNOTE
1. Economic Impacts of New Electricity Interconnectors by Anthony Swan Charles Rolph and Jane Melanie, paper delivered to Interconncet 99, AIC Conferences.
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