Structure of the market drives power prices up

16:00, Feb 07 2014

The Electricity Authority should be encouraging this debate, not trying to shut it down, writes Bryan Leyland.

There has been much debate on electricity pricing over the last few weeks and some of us have been criticised for claiming that prices are excessive.

When the market was set up, there was a general expectation that prices would decrease. Yet, as the chart in the recent report from the Electricity Authority shows, there has been a steady increase in prices since 2000. Why did this happen?

The answer is not simple. Prices have increased because of the flawed design of the electricity market and because of inept decisions on the way the market is regulated. It would seem that economic theory was given priority over the practical aspects of operating an electricity system.

In the "bad old days" when New Zealand was doing everything it could to extend electricity supply, bulk electricity was priced at £5 per kW of maximum demand. For an expanding system which was totally reliant on hydropower this made sense. Water was cheap but building new power stations and transmission lines to supply an hour or so of peak demand in the middle of winter was expensive. Basing the price on peak demand provided the lines companies and the consumers with handsome rewards for limiting demand by using hot water control systems.

These measures reduced peak demand by 15 per cent to 20 per cent. Because the rewards - lower power prices - were matched to the objectives - reducing peak demand - huge savings were made in the cost of electricity supply. Everybody benefited.


If we look at the present situation it becomes obvious that there are many situations where the rewards are not in line with the objective of a reliable and economical supply of electricity.

The virtual abandonment of limiting maximum demand by hot water control happened because, for some strange reason, it was decreed that the lines companies cannot profit from managing the demand of their consumers. As a result, most of the lines companies no longer make big efforts to manage peak demand and it is probably 300MW higher than it needs to be. The consumers pay for all the extra equipment needed to supply the demand. The problem could be fixed very easily.

Disturbances on the power system often result in a shortage of generation for a few hours. A high cost power plant is brought in to boost the supply and the price usually shoots up. The low-cost option would be to shed water heating load to compensate for the shortage. This is not done. The consumers pay. The problem could be fixed very easily.

The structure of the electricity market has also caused a substantial increase in prices. The primary problem is that the forces of competition that drive down prices in a conventional market do not apply in the electricity market because people cannot switch to a different energy supply when prices are high. Also, because the value of electricity is much greater than the price, most consumers pay up to keep the lights on or maintain production. So when the price increases, consumption hardly changes. Generators benefit from from the high prices resulting from keeping us on the edge of a shortage. In fact, they control prices for quite a large percentage of the time. For instance, a generator succeeded in manipulating South Island prices during May 2011 and succeeded in increasing the price to more than double what it would otherwise have been. The Commerce Commission and the Electricity Authority decided that this was within the rules!

The market pays all generators the same price regardless of their investment and operating costs. In genuinely competitive markets this drives down prices because an old plant is driven out of business because it has higher production costs. In the electricity business, the old hydropower stations provide the cheapest electricity and the newest stations are the most expensive. The single price means that the hydropower stations make huge windfall profits from the very high prices needed by a few new generators. The consumer pays.

The much-maligned Single Buyer Market was the option originally recommended and is an attractive alternative to the existing market. It would immediately solve many of the problems outlined above. Unfortunately the version offered by Labour/Greens, is a parody of a proper single buyer market and it should not be considered seriously.

The whole subject is one on which open debate and input from people experienced in the complexities of operating a power station is needed. Given the massive increase in prices subsequent to the introduction of the market, the Electricity Authority should be encouraging this debate, not trying to shut it down.

Bryan Leyland is a Power Systems engineer with wide international experience. He and his wife are part owners of a hydropower station that profits whenever the generators manipulate the market.


New Zealand was one of the first countries to introduce insulated storage water heaters and to use them for peak demand control.

The large storage capacity meant that consumers seldom noticed that their water heater had been switched off but, every month, they reaped the rewards in the form of lower power prices.

Peak demand was managed by a central control system commonly referred to as "ripple control" that ensured that demand was held constant from about 8am until 9pm in winter. This happens only in the upper South Island, now.