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Intervention vs liberalism in electricity markets – UK & NZ

By Lisa Harraway

The electricity markets that operate in the United Kingdom and New Zealand are quite different. Both countries enjoy a high degree of economic freedom. They rank 12th and 3rd respectively in the 2013 Economic Freedom of the World Index.

In the UK, the energy sector seems very liberal with generation, transmission, distribution and retail privately owned. In New Zealand, there are private companies that compete with state-owned, partially privatised companies and the grid is state-owned. One would expect the fully liberalised energy sector to outperform the partially state-owned sector, but this is not so.

Contrary to expectations, the energy sector in the UK is throttled by excessive regulation imposed by the Office of Gas and Electricity Markets (Ofgem) and onerous government green target policy. The privately owned National Grid is currently under attack by consumers for making excessive profits even though it has to charge prices regulated by Ofgem. At the same time, it is under extreme pressure from government and green parties to upgrade ageing infrastructure to cope with renewable energy demands. The National Grid is faced with a predicament. As a private company that needs to attract investors, it has to show a profit. Without investors, it will be the consumers who, through price increases, will cover the cost of any grid modernisation.

The UK electricity market is also subject to EU bureaucracy. Compliance with carbon emission and renewable energy targets imposes costs which are currently being directly and indirectly funded by consumers in the form of green levies and subsidies. Despite Europe’s economic fragility hindering agreement on climate policy, the European Commission is suggesting a 2030 target to cut carbon emissions by 40% and for at least 27% of energy to be generated from renewable sources. Perhaps the EU bureaucracy should allow the market to decide what it can afford.

Prices in Europe have been increasing since 2010. In Britain, price increases by the “big six” energy companies averaging 8%, came into effect early in 2014, sparking consumer dismay and heated political debate. Ed Milliband, opposition labour party leader, announced his intention to freeze energy bills for 20 months should he be elected in 2015, apparently with no regard for the disruption and electricity shortages such an action would cause.

To compensate for the price hikes, green levies have been reduced. The UK’s energy taxes, currently 9%, should fall by three or four percentage points. UK consumers, unlike elsewhere, are less reactive to price hikes so there was only a small increase in the number of consumers who switched energy companies. Great Britain has fallen from being the most active market in the world to number 12, with switching rates down from 21% to around 8%. This dramatic decline in competitive activity is closely linked to regulations prohibiting door-step selling practices and to regulators easing retail price increases. Complicated tariff structures and insufficient consumer awareness programmes have also contributed.

As only 15% of electricity in the UK is bought on the power exchange, changes in wholesale spot market prices are not passed on to the customer to the same extent as in Nordic countries where 77% of power consumption is bought on the Nord Pool Power exchange. In Britain, fixed-rate long term contracts to ease price volatilities are common. Spot-price-tied contracts, popular in Sweden and Finland, where the average monthly spot price plus mark-up constitutes the retail price, are not yet marketed domestically in Britain. It is not surprising then, that, in the UK, there is little correlation between wholesale and retail prices.

The changes that labour and the green parties are proposing, such as setting up a single buyer of electricity, are socialistic planning mechanisms. It would be more beneficial to actively encourage competition, to curb government intervention, cut subsidies to uncompetitive industries, and for Ofgem to cease its restrictive regulatory behaviour.

In New Zealand, there is minimal government intervention and pressure to adhere to politically motivated targets or restrictive regulations. Changes in energy legislation have been proactive in supporting a liberalised and undistorted market. Competition is encouraged. Responsibilities of market players are comprehensively defined so that prices and capital investments are transparent, and companies carry the costs of upgrading and improvement in the rollout of smart meters. The Electricity Authority operates as a governing authority and New Zealand energy, by and large, is unsubsidised.

In New Zealand, electricity prices have also increased dramatically over the last 20 years, but increases have been driven by environmental and market conditions outside of the utility companies’ control. Higher prices prior to the global recession were due to economic growth and increased demand.

In November 2013, the average price for electricity in the UK and New Zealand was around UK£0.172/kWh and NZ$0.275/kWh respectively. UK consumers were already losing out as by using purchasing power parities (PPPs) of roughly NZ$2 to UK£1 for comparison, they should have been paying only about UK£0.136/kWh to be on a par with New Zealand. Lack of competition in the UK electricity sector means that with the average 8% price increase that UK consumers have experienced this year, the average price paid for electricity is now UK£0.185/kWh, roughly 36% more than the average PPP price being paid by New Zealanders.

New Zealand has claimed the position as the most active electricity market in the world, with a switching rate of 27%.Outstanding marketing and public awareness campaigns and supporting regulations have boosted activity. Pressure on retail margins ensures the presence of a healthy, competitive electricity market. Consumers are reaping the benefits of a high level of energy security and economic prosperity.

Harraway is a researcher with the Free Market Foundation and the views expressed here are her own.

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