Market reforms to unlock innovation OECD hearing on radical innovation in the electricity sector

New Zealand

19 June 2017

• Background on New Zealand electricity markets

• Regulatory roles

• Efficient pricing

• Consumer friendly innovations

• managing and monitoring market power

• stress testing

• retailer default provisions

• Powerswitch

• smart meter roll-out

• sharing customer data

• Impacts on innovation and work in progress

2

Outline

3

Background on NZ electricity markets

• From the outset in 1996, the New Zealand spot market has used locational marginal

pricing (LMP) with co-optimisation of energy and reserves. There are approximately 250

nodes

• Except when scarcity pricing applies, there are no price caps

• There is no capacity market but there are futures and other hedge markets, including for

financial transmission rights

• There are markets for managing frequency, voltage support, over frequency-arming and

black start

• Over 80% of generation is renewable. Mainly hydro (56.7% in 2015) geothermal (17.3%)

and wind (5.4%). Some biofuels and solar (1.4%). The balance is gas (15.0%) and coal

(4.1%).

• Renewables up from 65% in mid-2000s. Limited hydro-storage, about 6-8 weeks supply

• Spot prices have wide diurnal variations and vary between seasons – higher in winter

4

Background on NZ electricity markets ctd

• The retail electricity market was fully deregulated in one-step in 1999

• Retail prices are not subject to price control. There are no default retailers or retail tariffs

• Distributors are limited by legislation as to their involvement in retailing and generation

• The six major retailers are vertically integrated generator-retailers

• There are approximately 20 other retailers, some of which own generation

• Switching is handled by a central registry and is perceived by consumers as very easy

• The annual switching rate is over 20%

• Most of the major gentailers are losing market share and most of the newer retailers are

gaining market share

• Electricity represents <3% of an average household’s total expenditure

5

Regulatory roles

• There are two regulators directly involved with the electricity sector. Both are independent

• The Commerce Commission (ComCom), the general competition and economic regulator

• The Electricity Authority (EA), the specialist electricity markets regulator

• The ComCom regulates the total revenue of the monopoly lines businesses

• All 30 (29 distributors and the grid owner) are subject to information disclosure requirements

• 17 distributors that are large or not owned by consumer trusts are subject to a default or

customised price-quality path regime

• Transpower, the national grid owner, is subject to an individual price-quality path

• The ComCom also regulates the grid investments of Transpower

• The EA sets the Code for the markets and monitors them and enforces Code compliance

• The EA contracts for the provision of market services, such as, system operation, registry,

settlement, pricing, reconciliation and provision of market information

• others

6

Pricing efficiency

• The LMP nature of the spot market means that prices at each node are the marginal cost

or value of increased withdrawal or injection of one unit of energy at that location

• Professor Wolak discusses the efficiency benefits of an LMP multi-settlement market in his

paper for this hearing

• NZ has a single-settlement ex post LMP market. There is no “day ahead market” and

prices are determined after the half-hour trading period, although there are forecasts of ex

post prices that are generally accurate.

• These features can compromise price efficiency to some degree but constrained on and

off payments are small

• The initial market design included a day ahead market but it failed to attract support. The

EA is exploring facilitating an “hours ahead market”

• The EA has a project to adopt ex ante pricing

• others

7

Pricing efficiency ctd

• Current transmission pricing:

• encourages inefficient use and by-pass of the grid by building and operating distributed generators

• adversely affects decisions on the location of investment in generation and

• encourages excess demand for grid investment as the costs are socialised but the benefits are not

• Current distribution pricing for households has low fixed charges and high charges based

on energy consumption and so:

• encourages excessive investment in photovoltaics and other energy saving devices

• discourages the adoption of batteries and other devices to exploit the diurnal variation in spot

prices, including electric vehicles

• does not encourage recharging electric vehicles at off-peak times

• The EA has projects underway to improve the efficiency of transmission and distribution

pricing so that they better support innovation

• others

8

Consumer friendly innovations: market power

• The way the NZ market was established led to market structures with high potential for the

exercise of market power:

• Four major vertically integrated gentailers with largely geographically distinct operating areas

• Limited hedge market options

• No Financial Transmission Rights

• No market monitoring role for the regulator

• Reforms introduced from 2010 addressed each of these issues:

• Two major power stations required to be transferred in ownership and “virtual” asset swap

contracts imposed

• Hedge market development facilitated

• FTRs introduced

• EA given market monitoring and reporting role

• others

9

Consumer friendly innovations: trading conduct

• In 2014 a “high standard of trading conduct” (HSTC) provision was added to the Code.

This applies to all trading behaviour including situations when generators are pivotal i.e.

when their output is required to meet all demand at one or more nodes

• The first case applying the HSTC provision was recently decided by the EA. It found one

of the major gentailers had breached the Code

10

Consumer friendly innovations: stress testing

• NZ’s market is not often prone to capacity constraints but the dependence on hydro and

limited storage make it prone to periodic energy shortages

• As Prof Wolak notes, the combination of a high share of renewables and an LMP market

can lead to high price volatility and significant financial risk for participants

• In 2012, NZ introduced stress-testing obligations for all retailers and major consumers:

• They have to report quarterly on what a period of sustained moderately high spot prices and a

shorter period of very high prices would do to their equity and liquidity

• They also have to certify annually that they have informed their governance board of the risks

• Retailers with customers with spot exposure are required to inform them of the risks they are

running and encourage them to conduct their own stress-testing

• The aggregated stress-test reports are published anonymously

11

Consumer friendly innovations: retailer default

• There are no default retailers or default tariffs in the New Zealand market. Every consumer

is responsible for engaging with a retailer of their choice

• In 2001, a major retailer went out of business because it was unwilling to sustain the

losses from high spot prices in a dry year relative to what it was charging its customers.

The retailer did not have generation and there was a very limited hedge market. It had

refused offers of hedges because it considered the prices were unreasonable

• The customers of the exiting retailer were transferred reasonably seamlessly to other

retailers, so there was little disruption to consumers

• EA research suggests one reason some customers do not switch is fear of retailer default

• In 2012, to ensure that the transfer of the clients of a potentially defaulting retailer would

be well managed, a multi-stage process to facilitate and, if necessary, require transfer of

consumers was developed by the EA and put into the Code

• To date this Code has not been needed but the reassurance is there for consumers

12

Consumer friendly innovations: Powerswitch

• Since 2011 the EA has run a multi-media marketing campaign called “What’s my number?”

• The objective has been to get consumers to check on a website how much they could

save by switching to a different retail package provided by their own or another retailer

• Consumer NZ, a not-for-profit and highly respected advocate for consumer rights, has

partnered with the EA in this campaign. It has also provided a website, Powerswitch, that

allows consumers to analyse the best deal for them and initiate the switch on-line

• Initially, Powerswitch was funded by the EA but recently the retailers voluntarily took over

funding about half the annual cost

• The EA thinks the provision of switching advice should be contestable. The retailers prefer

to deal with one provider, albeit a very independent and respected consumer advocate

• The EA worked with budget advisory services, public libraries and the offices of Members

of Parliament to assist lower income and more vulnerable consumers to use Powerswitch

13

Consumer friendly innovations: smart meters

• Soon after it was established in 2010 the EA confirmed that metering services should be

contestable.

• The EA decided to introduce some data exchange protocols but otherwise allow the

market to develop without regulatory intervention, provided it remained confident the

market was workably competitive

• The EA faced calls from several quarters to regulate the market more heavily, determine

the sort of meters and regulate who could have access to information and on what terms

• All these calls were resisted. The EA considers consumers are entitled to their own data

• The outcome is that smart meters have been rolled out to nearly 80 percent of residential

customers and almost all commercial and industrial customers.

• The meters have been funded by retailers and distributors without explicit charges

• There has been no major public backlash against smart meters. Complaints to Utilities

Disputes and the EA are more likely to be about not having one

14

Consumer friendly innovations: consumption data

• In a market in which spot prices vary a lot the time of use of consumption has a big impact

on the cost to a retailer (and lines companies) to serve a consumer

• A consumer’s current retailer knows the time profile of the consumer’s consumption,

whereas most other retailers will not

• To promote retail competition the EA introduced an amendment to the Code in 2016 that

requires a retailer to provide a consumer, or an agent nominated by the consumer, with

the consumers’ actual half-hour consumption data over the preceding two year. The data

must be provided free up to four times a year.

• The EA also made connection point technical details publicly available

• This Code change probably had more impact on retail competition for medium-sized

commercial customers than for households.

• Incumbent retailers have attempted to stymie the EA’s intention using Privacy laws but

these do not apply to businesses

15

Impacts on innovation: dynamic pricing

• As Professor Wolak’s paper foreshadows, the changes NZ has introduced has led to

household and small business consumers being able to buy based on spot prices at the

node serving them

• There are currently three retailers offering this form of contract. One is the fastest growing

retailer in the market. It counts among its major shareholders NZ’s largest fund manager

• This retailer bills weekly and provides its customers with a running total of what they have

saved compared with if they had stayed on their previous contract

• It offers its customers actionable price information in the form of texts with price forecasts

and data on the percentage of renewables in current production

• Other retailers offer plans that are at least partially time-of-use based. One offers a “free

hour of power” a day to attract those that can shift some of their load to a time when prices

are generally low

• Electricity demand has proved to be quite price elastic with actionable information

16

Impacts on innovation: technology

• Consumers in New Zealand have not shown the enthusiasm for photovoltaics that those in

other countries have done. It is seen as having a place but not as necessarily cost efficient

or an effective way to reduce greenhouse emissions

• There is currently 50MW of solar, which is 0.5% of total capacity

• There has been no mandated feed-in tariff or other subsidy to support photovoltaics but, in

addition, the information that distribution tariffs need to change to be more cost-reflective

has been spread widely and accepted by most consumers

• On the other hand, there is strong and rapidly growing interest in technologies that can

manage demand and take advantage of NZ’s diurnal variations in spot prices:

• smart batteries at grid and individual consumer level that can respond to energy prices and

distribution and grid requirements

• smart controls for hot water cylinders, freezers, cool-stores, lighting etc that take account of price

• electric vehicles that can be slow charged at night when prices are usually low

17

Summary

• New Zealand’s experience with attempting to unlock innovation in the electricity sector

provides support for many of the points made in the papers prepared for this hearing by

Prof Wolak and Prof Lavrijssen:

• The importance of efficient prices for energy, transmission and distribution as the basis for the

efficient adoption of new technology

• The need to make customer friendly innovations to:

• deal with local and system wide market power issues

• mitigate the likelihood and impact of retailer default due to volatile prices

• inform customers about offerings in a manner they can use

• provide customers with access to dynamic prices, actionable information and choice

• allow wider access to consumption data

18

Work in progress

• While New Zealand has done quite a lot to reform its markets to unlock for consumers the

benefits of electricity innovations there is still work for it to do:

• Reform transmission and distribution pricing to make them more service-based and cost-

reflective to support efficient adoption of new technology

• Tweak the working of its LMP spot market by making it ex ante to make actionable data more

readily available and accurate

• Overcome the attempts of incumbent retailers to stymie wider access to consumption data

• Make it easier for consumers to transact with multiple parties so they can buy off or sell output

to different parties e.g. sell solar surplus peer-to-peer but buy off one or more retailers when

net purchaser

• Explore whether and how households and other smaller consumers can by-pass using retailers

by buying and settling in the spot market directly

19

Work in progress ctd

• The adoption of new technology is resulting in the blurring of boundaries between

monopoly electricity distributors and (potentially) competitive markets for:

• electric vehicle rapid charging stations

• battery installation, leasing and control in networks and customers’ premises

• peer-to-peer trading platforms

• solar panel installation and leasing

• demand management services for grid and network reliability and market purposes

20

Electricity distributors’ involvement in new markets

• Widespread acceptance that emerging technologies capable of being provided

in workably competitive markets

• Key question: should regulated monopolies be allowed to operate in unregulated

(competitive) markets?

• The tradeoff: net benefits of integration vs net benefits of separation

Key risks Separation Integration

Cross-subsidisation

Anticompetitive discrimination (price and non-price)

Economies of scope

Transaction costs

• Weakening (demise?) of energy networks’ natural monopoly?

21

ComCom’s decisions on its 2016 review of the rules

• Distributors’ involvement in new markets:

• Legislative requirement that cost allocation rules should not unduly deter distributors’ investment in

the provision of other regulated and unregulated services

• Too early to determine which “side of the tradeoff” dominates

• Tightened cost allocation rules to allow some sharing of economies of scope but avoid cross-

subsidisation between regulated and unregulated services

Removed standalone ‘Avoidable Cost Allocation Methodology’ and

Reinforced requirement to justify use of proxy cost allocators

• Currently reviewing related party transaction rules (in house vs market supply)

• Competition provisions may also apply in relevant circumstances

• Risk of electricity distribution asset/network stranding (death spiral):

• Evidence suggests low risk in short-to-medium term that electricity distributors fail to recover

invested capital. Increased uncertainty over longer term

• Precautionary measure: introduce option of slightly faster cost recovery through shortened

regulatory asset lives; maintain incentives for future investment

• Herfindahl-Hirschmann Index (HHI) in NZ retail

market has reduced markedly

22

Appendix: Retail competition has increased greatly in

NZ in last decade

HHI 2006 2016

10,000 = monopoly, 0 = perfect competition

Also:

Approx. 20% switching rate per

year

Nearly 80% connections have a

smart meter without subsidies or

mandate