The Commerce Commission on electricity markets (updated x3)

Looking at the media release from the Commerce Commission on its electricity markets investigation, this statement stood out for me,

By comparing the actual wholesale prices with hypothetical competitive benchmark prices, Professor Wolak estimated that the wholesale prices charged over the period 2001 to mid-2007 resulted in an extra $4.3 billion in earnings to all generators over those that they would have earned under competitive conditions. This suggests that wholesale prices were, on average, 18 per cent higher than they would have been if the wholesale market had been more competitive, and the gentailers had not been able to exert market power. Less competition was especially evident in the wholesale market during the dry years of 2001 and 2003, when additional earnings attributable to the exercise of market power are estimated at $1.5 billion in each of those years.

If this means what it says and the benchmark for the investigation was a perfectly competitive market then I'm not sure what the investigation is worth.

The problem is that I'm not sure that a competitive benchmark is the right benchmark. A market like electricity will never be perfectly competitive, the cost structure is such that this will not happen. In particular the size of fixed costs would result in non-perfectly competitive conditions. I would think that having just four firms - Contact, Genesis, Meridian and Mighty River Power - control 85 per cent of total capacity is a result of the cost structure of the industry. So how likely is it that the industry will ever be competitive? Next to zero probability would be my guess. So what the Commerce Commission is doing is comparing reality with the impossible. And funnily enough reality doesn't match up.

As noted above, in the press release we are told,

Professor Wolak estimated that the wholesale prices charged over the period 2001 to mid-2007 resulted in an extra $4.3 billion in earnings to all generators over those that they would have earned under competitive conditions. This suggests that wholesale prices were, on average, 18 per cent higher than they would have been if the wholesale market had been more competitive, and the gentailers had not been able to exert market power.

So there were $4.3 billion in earnings to all generators over those that they would have earned under competitive conditions, but competitive conditions are impossible, so what does this tells us. Reality isn't as good as an impossible to implement theoretical standard? That isn't at all surprising. To say that pole-vaulting records are pretty awful compared to those we could archive in a gravity free world isn't saying much.

Surely a better standard of comparison would have to be ask what alternative feasible, implementable industry structures are there and is the best of these likely to give better results? If so, then compare the New Zealand situation to this real world alternative and then see how large any excess earnings are.

Then at least if our current market structure falls short we have an idea of what changes to make. If we accept the Commerce Commission's results, what are we to do? Their report seems to gives no guidance as to what changes to make as we can never have a perfectly competitive industry.

To be fair to the Commerce Commission I have not read all 6 parts that make up their 500 page report, and they may cover these issues somewhere in the middle of all those pages. But its not clear to me from their public statements that they have.

Update: MacDoctor comments on the CC's report here, Kiwi Polemicist comments here and BK Drinkwater comments here and here.

Update 2: On reading comments by Colin Espiner, via BK Drinkwater, I came across this bit,

The Comcom says that according to the work of eminent scientist Professor Frank Wolak, the amount of overcharging by power companies amounted to around $4.3 billion over the past six years - that's $1000 for every man, woman, and child in the country.

I'd like my $1000 back, please

But that's the problem Colin mate, you can't get it back because it was never there. If the Commerce Commission have done what it looks like they have done, then the $1000 is mythical, it appears only if you compare reality with the impossible. But you are a journalist, so such a comparison probably seems reasonable.

Update 3: goonix writes In defence of the New Zealand wholesale electricity market