In its quest to lower electricity prices for New Zealand households, the Electricity Authority may inadvertently make the situation worse.<\/p>\n
This week, the authority announced plans<\/a> to require New Zealand\u2019s \u201cgentailers\u201d \u2013 firms that both generate electricity and retail it to consumers \u2013 to offer the same supply terms to independent retailers as they do to their own retail arms.<\/p>\n The aim is to prevent the gentailers from providing discounted electricity to themselves, thereby levelling the playing field between retailers, to deepen competition and lower prices.<\/p>\n Yet while greater competition and lower prices sound appealing, such expectations rest on a na\u00efve understanding of how New Zealand\u2019s electricity market works.<\/p>\n Upward pressure<\/p>\n Under current rules, New Zealand\u2019s gentailers \u2013 notably Genesis, Meridian, Mercury and Contact \u2013 can supply their own retail arms at prices that reflect their cost of generation, which is typically lower than the wholesale market price.<\/p>\n Retailers without generation capacity must buy electricity at these higher wholesale prices, making it hard to compete with vertically integrated gentailers.<\/p>\n The authority expects gentailers to offer all retailers \u2013 including rivals \u2013 the same low prices they give themselves.<\/p>\n But no firm wants to offer rivals the lower prices that come from investing in the infrastructure to generate power themselves. <\/p>\n Instead, the proposed rule could induce gentailers to raise the price charged to their retail arms \u2013 thereby pushing up retail supply costs for everyone.<\/p>\n The risk of collusion<\/p>\n Even in the absence of outright collusion, there is a risk the new rules could still raise prices.<\/p>\n If a gentailer discounts the supply price it charges its own retail arm, it must then offer that same rate to its competitors. <\/p>\n Gentailers may conclude it is better to withhold discounts entirely. Since the proposed rule means they all face the same incentive, a de facto consensus to keep wholesale prices high could result \u2013 without them ever having to coordinate directly.<\/p>\n Rather than fostering competition, the rule creates an anti-competitive focal point. It may improve the relative position of independent retailers, but at the cost of worse outcomes overall \u2013 for consumers in particular.<\/p>\n This should not be surprising. Similar distortions have been observed in other sectors, often resulting from \u201cbest-price guarantees<\/a>\u201d or \u201cmost-favoured-nation clauses<\/a>\u201d. In these cases, firms pledge to match or beat rivals\u2019 lower prices, or not to offer better deals to any single customer.<\/p>\n Likewise, \u201creference pricing\u201d rules that cap United States\u2019 pharmaceutical prices at levels set in other countries have been shown<\/a> to raise prices overseas rather than significantly drop prices in the US.<\/p>\n Though seemingly good for consumers, these commitments can suppress price competition by deterring firms from undercutting each other altogether. <\/p>\n A questionable compromise<\/p>\n My research<\/a> has explored competition in electricity markets where gentailers compete with standalone retailers. <\/p>\n I found integration between generation and retailing \u2013 the gentailer model \u2013 tends to deliver the best outcomes for consumers in a wide range of settings. Other studies<\/a> examining electricity systems internationally have reached similar conclusions.<\/p>\n But consumers tend to fare worst in systems where vertical integration is prohibited. Ironically, independent retailers can also fare worse under such arrangements. This is because, despite often calling for the break up of gentailers, the vertical separation triggers higher wholesale prices.<\/p>\n The authority\u2019s proposal represents a kind of middle ground: retaining vertical integration while using regulation to force gentailers to behave as if they were separated entities.<\/p>\n