• John Luxton
Commerce and Industry

Thank you for the opportunity to address you today. AS Minister of Commerce responsible for competition law and as a former Minister of Energy, I am delighted to be here.

The topics I would like to cover are:

the Coalitions core economic principles
the Governments energy policy
the outcome of recent wholesale electricity market reforms
developments in the retail sector of the industry, including the information disclosure regulations and consumer contracts
current concerns with transmission pricing
I would be happy to take questions in the time available at the end.

The Coalitions core economic principles The Governments overall strategy is contained in the Coalition Agreement.

It specifies the agreed principles which will guide our decision-making during the next three years.

As the Treasurer said in his 11 February speech, our strategy has a multi-year focus. As a Government, we will not be drawn into short-term crisis management.

Four core economic principles lie at the heart of the Governments strategy. These are:

providing sound, stable government on an agreed basis, implementing orthodox economic principles in line with, or better than, the best international practice for a forward looking, successful democracy;

ensuring there is an economic climate that is conducive to sustainable development and growth, to achieve more employment opportunities, high quality education and social services, through a strong commitment to low inflation, prudent and conservative fiscal management and, over time, lower taxes and reduced public debt;

maintaining an open, internationally competitive economy, supporting a strong export sector, particularly by managing cost structures downwards and continuing deregulation and policies to stimulate private sector and individual performance;

planning for the countrys future not only by ensuring that a strong economy is central to the Governments policies but also by placing emphasis on inter-generational fairness and on increasing the national savings rate.
We deferred tax reductions in 1997/98 to ensure that additional government spending does not add to inflationary pressure. As the Treasurer noted, the net fiscal change over previous plans for 1997/98 will be small - at most $200 million.

Further, the promise of additional spending does not relieve the Government of its responsibility to demand value for money. The Government will ensure that the maximum benefit for New Zealanders is gained from the resources available.

In summary, the key to maintaining an open internationally competitive economy will be:

stable macroeconomic policies;
deregulated, competitive and open markets;
quality public services provided as efficiently as possible; and
the lowest possible tax rates.
The Governments Energy Policy
The Coalition Agreement also sets out the Governments energy policy for the next three years and beyond.

The policy objective remains to ensure the ongoing availability of energy services, at the lowest cost to the economy as a whole, consistent with sustainable development.

Specific policies involve:

retaining Contact, ECNZ and Trans Power in Crown ownership.
reviewing energy prices in detail, in particular the way prices are charged for the Cook Strait cable; and
promoting efficiency and conservation.
The themes underlying this policy are efficiency, competition and ongoing pressure for innovation and cost minimisation throughout the energy sector, including in the electricity industry.

In the longer term, efficiency is not about protecting the position of existing participants.

Nor is it about determining appropriate recipients for cross-subsidies.

Rather, efficiency involves allowing markets to give the correct signals for consumption, production and investment decisions.

The Outcome of Recent Wholesale Electricity Market Reforms As you know, the wholesale market has now been operating for almost five months, following its commencement on 1 October 1996.

The first few months were characterised by substantial variation in prices between half hours, with some extremely high prices for short periods of time.

While the unwarranted price volatility was of concern, it reflected the fact that many market participants needed time to adapt their systems to the new environment.

For the market to work properly spot market prices need to rise whenever supply is temporarily insufficient to meet demand.

The fact that the Government did not intervene during the markets first few months can be interpreted as a sign that we want the wholesale market to function without arbitrary caps or floors on wholesale prices.

We know that in the markets early months average wholesale prices were lower than for the corresponding months of last year, despite the temporary high prices.

Average price data must be interpreted cautiously because the market is still settling in and because lake levels differ markedly from year to year.

Of course, the appropriate response for companies concerned about falling lake levels is for them to obtain sufficient hedging contracts through the market, and to actively pursue demand-side management opportunities.

The Government does not underwrite the performance of supply companies or the decisions of major users.

All participants have now had ample opportunity to identify and manage their risks.

However, in a competitive environment the nature of these risks can change rapidly. The more profitable companies are likely to be the ones that actively monitor and manage their risks.

The low turnover in the secondary market for hedges suggests that there is more that the industry can do to promote risk management.

Looking back at the reforms, what is surprising is that the New Zealand electricity system operated for so many years without variable half-hourly pricing and without major users having strong incentives to reduce demand during shortages.

The day-ahead market is not actively trading and EMCO is currently examining the reasons for this.

The day-ahead market could be a useful tool for demand side management in particular, but it is not essential for an efficient spot market.

The way forward is for the industry to identify participants needs and design the market arrangements that meet these needs.

The Government has no special insights that would enable it to determine the best market arrangements.

Developments in the Retail Sector of the Industry The objective of the reforms is to obtain efficiency gains that can be passed on to consumers and shareholders.

It is clear that major users have already been major beneficiaries of the electricity sector reforms in recent years.

Electricity prices to commercial users have fallen by nearly 30%, in real terms, since 1985.

While household prices have fallen slightly, in real terms, over the same period, they have tended to rise in the last few years. This reflects the removal of cross-subsidies and takes no account of dividends and rebates that supply companies pay to their owners.

I therefore share the concerns of my colleague, the Minister of Energy, that smaller consumers, including households, have yet to see significant direct benefits from the reforms.

I know that Ministers, and indeed the Commerce Commission, are taking an active interest in the performance of supply companies and will take steps against any that take advantage of a dominant market position to exploit captive consumers.

Some supply companies have defended their pricing policies by noting that approximately 70% of their costs arise from SOEs or from Government taxes and charges.

Indeed, taxes are an unavoidable fact of doing business.

However, in a deregulated market, companies are not obliged to buy from SOEs, although I appreciate it will take time for substantial private sector capacity to enter the market.

In the meantime, the separation of Contact from ECNZ has implemented competition between generators and the Government is keen for the benefits of competition to be passed on promptly to consumers.

I would like to emphasise that competition between generators is not about preventing SOEs from earning a reasonable rate of return. It is about ensuring a high level of customer responsiveness by generators.

It is interesting to note that the separation occurred on 1 February 1996, so Contact has now been fully operational for more than a year.

Information disclosure regime The Government would like to see further development of competition in the retail electricity sector.

The information disclosure regime is already supplying useful comparisons between supply companies as analysts and consumers work through the data now publicly available.

However, there are some areas where the regime can be strengthened, as outlined in a recent Discussion Paper released by the Ministry of Commerce.

In particular, the Ministry is looking to tighten the accounting ring-fencing of natural monopoly - lines - businesses and contestable - generation and retailing - businesses. This is in order to obtain more comparable, reliable and robust information from electricity companies.

At the heart of this, the Ministry is looking at introducing mandatory accounting guidelines, which define the line business as narrowly as possible - stripping out any contestable elements that electricity companies, to date, have been able to hide in their line businesses.

Once the consultation phase is completed, the Government will move to make the necessary regulatory changes so that the regime fully meets its goals. I am pleased to see that the Commerce Commission has announced the end of the honeymoon period for electricity companies, in terms of coming to grips with the Commerce Act, and is taking a pro-active approach to policing the industry. Last year it send please explain letters to many electricity companies based on their 1995/96 disclosure information and commenced court proceedings against Southpower for alleged breaches of the Commerce Act.

Consumer contracts
Consumers have benefited immensely from competition in air travel and telephone businesses, although there is still room for improvement in these industries.

The Government is convinced that similar advances are possible in electricity, whether through improved service, lower prices, or both.

You will all be aware of work by the Ministry of Consumer Affairs that identified unsatisfactory terms in the customer contracts of many supply companies.

You will also have seen the comments by the Minister of Consumer Affairs and the Minister of Energy that call for significant improvements over the next few months.

The Government is pleased to see that most companies are now reviewing their contracts in the light of the adverse publicity.

Of course, it is in supply companies own commercial interests to offer high quality customer services.

Current Concerns with Transmission Pricing
The extent of independence between the SOEs can be seen in the current debate on pricing for the Cook Strait cable. It is clear that each SOE is negotiating strongly in its own commercial interests. This is just as it should be, even if it means the issue cannot be immediately resolved.

The SOEs all face pressure to earn a reasonable rate of return, and cannot easily do so if disgruntled customers decide not to pay their bills.

However, non-payment is not a long term solution to contractual disputes. As every residential customer knows, those who dont pay their power bills face the debt collector and run the risk of disconnection.

Some consider that if the wholesale market had been delayed by a few months then transmission pricing could have been sorted out once and for all.

I doubt that this is so - to my knowledge transmission pricing has been highly contentious throughout the 1990s and it is unlikely that a few extra months would have solved the problems.

The Government is keen to see a resolution to the Cook Strait cable pricing issue.

The Government has made it clear that its primary concern is that resolution is consistent with the our efficiency objectives for transmission pricing. These are contained in the Governments section 26 statement on transmission pricing to the Commerce Commission.

The Government has also made it clear that it would like the issue to be resolved in a timely fashion.

The Coalition Agreement provides for the Cook Strait cable pricing issue to be reviewed with the fairness of both Islands in mind. The Government is monitoring the negotiations closely.

However, the issues are highly technical and they are important. An inefficient transmission pricing regime could lead to poor decisions on the timing and location of new generation projects. Concluding Remarks

The electricity industry has faced a comprehensive series of reforms since 1987. As a result, New Zealand now has a wholesale market the envy of many larger countries and the building blocks for retail competition are in place.

In concluding my address to you today I would like to call upon all the industry participants to rise to the challenges of the market place by seeking innovative new ways to meet customers changing demands. Thank you.