Market Forces in Electricity Attacked

Worth A Look, Energy, Frontier Centre

Across the world, very significantly lower electricity prices have resulted from replacing the monopoly supply of electricity with independent competing firms. Competition in electricity supply is doing the job it is supposed to do. It brings cost reductions as firms try to steal a march on their competitors followed by price reductions as the competitors catch up. In many cases the competitive process has resulted in the suppliers ‘finding’ more capacity as a result of achieving higher levels of reliability. Its price outcomes have also encouraged firms to build new capacity where it is most needed—in Victoria’s case to supply peak demand.

But the shift from government to market control has brought many anxieties. Will new power stations be built to avoid shortages? Will new power line extensions be built as and when needed? How will we prevent power stations colluding to drive up prices when some concentration of ownership is inevitable?

In addition, governments have overlaid on the industry a raft of social and environmental policies—designed to reduce greenhouse gas emissions, ensure lower rural prices, ensure speedy rectification of faults, and so on.

Many government interventions, including those addressing the anxieties about the responsiveness of the market, give rise to consequential problems. For example, government requirements to keep prices down will reduce the incentive for new power plant construction.

There are myriad such concerns and, as a result, a seemingly endless series of inquiries and reviews into the industry. Even so, the potency of market-based approaches for improving electricity supply and keeping down prices is almost universally accepted. Where they have failed, as in California, the consensus is that this is as a result of poor market design and factors unrelated to the market itself, like NIMBY objections to new plant and power lines.

One area that gives rise to considerable tension concerns transmission—the long distance transport of electricity from power station s to users. Transmission is expensive, especially in geographically disbursed markets like Australia and North America, where delivering power over long distances can entail costs similar to building a local new power station.

As with highways, there are debates about whether transport of electricity should be paid for out of some general revenue pool or directly by the users, rather like a toll system. However, transport of electricity is more complicated than the transport of people and goods by road.

First off, electricity is not easily controlled. Once it is generated and put into wires, it obeys the laws of physics and moves along paths of least resistance rather than along paths that users want it to travel. This makes for great difficulties in setting a transport price in line with costs.

Secondly, electricity transmission lines can dramatically affect electricity supply costs. Businesses will locate new power stations to take advantage of the cheapest combination of transport and production costs. A transmission charge on users or suppliers that does not fully account for the different location costs means some users and suppliers are subsidized. Such a subsidy might, to use an extreme example, encourage a firm to site a power station at Moomba to take advantage of local gas supplies with inadequate regard for the cost of building a transmission line to get the electricity to Sydney, Adelaide or Melbourne.

By the same token, a new line may lower the costs of a more remote power source thereby disadvantaging a rival supplier and disincentivising anyone from building plant close to the market even though that might be the least cost solution.

Ensuring the full costs are placed on the beneficiaries becomes crucial to avoid wasteful over-building of transmission lines.

Means of achieving this have brought lively debate across a great many countries. One promising approach is to treat new transmission in a similar way to new generation—requiring it to find commercial parties who will finance it. Some greater possibilities of this have been offered by Direct Current (DC) technology. Unlike conventional Alternating Current technology, DC allows the power to be controlled so that electricity can be supplied to the buyer from the seller only if the two parties agree on terms. Such a transmission facility becomes like a power station that buys in electricity from an area where it is cheap and sells it to a higher priced area. It also may offer a remotely located generator guaranteed access to a market, a very valuable service for electricity where prices can suddenly rise due to demand surges or production outages.

TransEnergie, a subsidiary of Quebec Hydro, has built a DC interlink between Victoria and South Australia, which relies on sales of capacity to those wanting to export or import between the two areas. Naturally, this could not earn income in competition with ample ‘free’ capacity paid for by charges smeared across all users. But NSW government owned transmission business, Transgrid wants to build such a rival link. That link, financed by a compulsory charge, would destroy the capability of TransEnergie’s ‘entrepreneurial’ link to find paying customers.

The matter has already seen a five year regulatory battle with the latest round in Transgrid’s favour. If allowed to stand, the present decision will mean that all future links will rely on regulatory judgements, not those of the market place. Not only would this spell the end of market-driven transmission developments, but it will also mean that proposals for new power stations would face a risk that new transmission links would undermine their profitability.

Departing from a market-based outcome might well bring short term benefits to the consumer by bringing on a new supply source. But when this imposes risks on the viability of future developments it undermines the conditions for a stable and self regulated industry development. Finding an accommodation between the market-based provision of new transmission and transmission financed by mandatory customer charges is therefore one of the most pressing issues facing the electricity industry.

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