Statement to the Commerce Commission of the Economic Policy of the Government: Development of a Competitive Wholesale Electricity Market To the Commerce Commission Pursuant to section 26 of the Commerce Act 1986, I hereby transmit to the Commerce Commission a statement of the economic policy of the Government in relation to the development of a competitive wholesale electricity market in New Zealand. Broad Objectives The Government's overall policy objective is to ensure the continuing availability of energy services at least cost to the economy as a whole, consistent with sustainable development. Specific Outcomes To achieve the overall objective, the Government considers that the following outcomes are necessary: Pressure on prices and costs: Real and sustained pressure on electricity prices and costs, especially in the area of new investment, over the next 10 years and beyond. It is vital to the economy that we see stronger pressures on electricity producers to be efficient and innovative to look for last-cost solutions; and Accurate price signals: Pricing electricity in a manner which signals the full cost of producing an extra unit of electricity. Investors and consumers in the wider economy can then make decisions which seek to get the most value from each extra unit of electricity they purchase. Possible Mechanisms Three broad policy options were considered by the Government: No change: Maintain the current market structure with: ECNZ as a highly dominant generator (96% of electricity production) which seeks to maximise value over time and avoid Government intervention; Trans Power as a separate state-owned enterprise operating the national grid as a successful business to ensure efficiency, reliability and security; Corporatised distribution and retail companies operating under the Energy Companies Act 1993; Private firms providing energy trading services; or Workable or effective competition: Move to an environment where wholesale electricity prices are determined by workable or effective competition, with buyers and sellers of electricity taking responsibility for managing their respective risks independently of the Government; or Stronger regulation: Introduce more rigorous regulation. Several options are available, including direct regulation of ECNZ's prices or direct oversight of investments in new generation and wholesale electricity prices by an independent agency (such as a monopoly wholesaler). Privatisation is not an option. Nor is any restructuring that has as its aim the sale of any significant component of ECNZ. Preferred Policy After careful consideration of the options, including the final report of the Wholesale Electricity Market Development Group, the Government has concluded that the objectives and outcomes set out above would be best achieved by workable or effective competition, in particular: Vigorous competition from private sector generation and demand-side management to meet new electricity demand; A diversity of prices and other conditions for selling electricity on contract; and Competitive disciplines on prices for electricity in the sport market. Barriers to Robust Rivalry The Government identified the following main barriers to effective and workable competition: ECNZ's profound dominance in the spot, contracts and new investment markets; The market's uncertainty as to the role Governments will play over time in relation to pricing and new investment decisions; The uncertainty these two factors cause in relation to expectations of future electricity prices. There are no robust mechanisms from which participants can project and respond to market prices. Rate and Manner of Change It is important for the New Zealand economy and environment that these barriers are overcome in a manner and at a rate that: Recognises the particular characteristics of the New Zealand electricity system; Maintains security of supply; and Enables producers, distributors, retailers and consumers to develop systems, skills and experience necessary to operate effectively in a competitive environment. Reform Package After carefully evaluating all the relevant factors, the Government has agreed to a reform package which is set in a Memorandum of Understanding with ECNZ, together with four policy statements, all dated 8 June 1995. The main elements of the reform package are summarised as follows: Transfer of ECNZ assets: Subject to obtaining all necessary statutory consents (including Commerce Act clearance or authorisation, if required), transferring around 30% or ECNZ'S assets and liabilities, including ECNZ's interests in the Maui gas contract, to a new SOE within various financial and implementation parameters; Restraints on ECNZ: Imposing by notice under section 13 of the State-Owned Enterprises Act 1986 certain restraints on ECNZ: namely, a `cap' on ECNZ providing more than 50% of additional generating capacity; a requirement for it to `ring-fence' additional capacity; a requirement for ECNZ to offer each year a minimum proportion of its capacity on contracts; and a continuing restraint on ECNZ acquiring any electricity supply authorities (now `energy companies') Sale of gas: Completing the sale by ECNZ of around 22PJ pa of gas: contractual arrangements for the sale of this gas are expected to lead to the introduction of a significant new, private power producer; Sale of small hydro stations: Subject to appropriate consultation with Maori on Treaty issues, selling six groups of ECNZ's small hydro stations to energy companies and/or Maori within the region of each station; and Related policy statements: Issuing four policy statements on related issues: covering electricity pricing, the management of `dry year' risk, the regulations of distribution lines businesses and public policy objectives for the pooling of electricity supplied by competing generators. Implementation of these measures will be a significant step toward overcoming the barriers referred to above and developing a competitive wholesale electricity market. Further Steps The Government will closely monitor the results achieved from implementing these measures against the objectives set out above. Further evolutionary steps toward a competitive wholesale electricity market will be considered as appropriate. Conclusion In the Government's view, workable or effective competition in the wholesale electricity sector offers the best prospects over time of improving welfare, including: A more efficient allocation of risk; Stronger pressures for innovation and cost-minimisation; More efficient investment decisions in new generation and demand-side management options; and, in turn A more efficient allocation of resources in the economy and less harm to the environment. Signed at Wellington this 12th day of December 1995. PHILIP BURDON, Minister of Commerce. In other policy material issued by the Government on wholesale electricity market issues the Memorandum of Understanding dated 8 June 1995 referred to below, for example the Government has used the expression ``sustained and robust rivalry''. This is intended to have the same meaning as ``workable or effective competition''. In mid 1993, the Government established the Wholesale Electricity Market Development Group (WEMDG) a cross-section of industry and consumer groups to evaluate a range of reform options. In their final report to the Government in early September 1994, the members of the WEMDG Board recommended a set of measures to facilitate the development of a competitive wholesale electricity market in New Zealand.