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Everywhere you look, there are signs of reduced economic activity. Retail spending, housing, capital expenditures, the hospitality industry, even the number of cars on the morning commute. All of them are down significantly.
Economic data, though often late, confirms what we have seen and felt. Just yesterday, concrete production, an important indicator of economic activity, fell by about 10% year-on-year. In some industries, people are beginning to compare the current environment to 1987.
In that sense, monetary policy is working. The Reserve Bank is restraining us to correct policy excesses during the COVID-19 pandemic. Having the same governor who created the mess in charge of cleaning up the mess makes it more difficult to respond, but that is another story.
The key question is whether he and his bank can get the timing of interest rate cuts right, without cutting too far and tanking the economy. We will learn more next week.
With the pulse of our economy right now, it wouldn’t take much additional stress to completely shut down the economy.
Even a moderately sized black swan event could have a significant impact, and business owners will be nervously watching the future. There are many things you might worry about, like the Chinese economy, a global stock market crash (which almost happened this week), or an all-out war in the Middle East. But there is one issue looming much closer to home that governments should be very worried about.
The New Zealand energy market has been in a slow motion for some time, but things are getting worse. Prices are skyrocketing, spot prices are ridiculous, consumers are being hurt, electricity retailers are abandoning the market, and major industrial users across the country are cutting back operations. All of this can only put downward pressure on broader economic activity.
The energy sector has been treated as a political plaything for the past six years. The Ardern Government’s sudden ban on oil and gas exploration has had a huge chilling effect on the gas industry and international investment more broadly. With this captain’s order, New Zealand’s sovereign risk has risen significantly and our reputation as a predictable place for people to invest and create jobs has been wiped out.
But that’s not all. The decision to build the Onslow Dam was a doomed decision, which dealt a further blow to the power industry’s investment in power generation. Who would want to invest hundreds of millions of dollars in a power plant when the government is threatening to build a massive state-owned dam that simply doesn’t make sense economically and is priced to completely destroy your investment? It’s no surprise that many other power generation projects have been shelved.
Of course, these problems are now a thing of the past. The question is what the current government will do to address the problems we currently face. These include continued low levels of investment in power generation and electricity prices that are among the highest in the Western world.
Both of these questions are somewhat counterintuitive. Conventional economic theory would dictate that rising prices indicate excess demand, thus encouraging the introduction of more supply. But the reason this is not happening here may be due to market structure.
In New Zealand, generators are allowed to operate retail businesses and are currently permitted to manage pricing between the two sectors in a way that makes it difficult for new competitors to emerge.
Recent experience has shown that it is almost impossible for new retail companies to succeed in this market because, with current pricing, retail companies choose to make money from the generation side rather than the retail side. Conversely, there is little incentive for new generators to enter the market because there are no independent retailers with a customer base to which they can sell electricity.
The end result is that our current crop of gentlemen have pretty much monopolized the field, and they’re doing just fine, thank you. Their interest is in leveraging existing assets for as long as possible, and only nurturing new generations at the margins.
All of this bears a striking resemblance to vertically integrated Telecom New Zealand, which has gone to great lengths to maintain its structural advantages and has worked hard to maintain its old copper phone network rather than build fiber to the home.
Competition in the telecoms sector has been fierce ever since the government’s superfast broadband programme (which I was involved in) prompted telcos to spin off infrastructure unit Chorus and retailer Spark and build fibre.
If all this were widely known, what would regulators do?
One problem is that we have two regulators involved. The Commerce Commission seems more concerned with international sales of small tech companies than the state of one of our most important industries; and the Electricity Authority (EA) has an almost lackadaisical attitude towards regulating the electricity market. The two of them stand at the regulatory door like two old gentlemen saying “you go first”. In the telecoms sector, the Commissioner and its powers belong to the Commerce Commission.
The EA itself seems confused about what the problem is and how to fix it. It has written numerous reports on the issue and taken some ineffective regulatory actions, but inertia seems to be its calling card. No wonder Shane Jones called it a “chocolate teapot” this week.
Ministers do seem to be aware of the risks. Energy Secretary Simeon Brown is starting to increase pressure on the IEA to act, but it is not clear they know how. Politically, we are rapidly approaching the point where simply prodding the IEA will not be enough.
There is a range of regulatory tools available, from transparent pricing between generators and the retail sector (available to all) to operational separation or, most radically, full structural separation. These tools have been tried in a range of countries with notable success.
Clearly, someone needs to act to lower prices and increase generation. If regulators don’t act, then the government must. We can’t allow our economy to suffer further because of structural flaws in our most important utility industry.
Finally, this column lost its most loyal reader in the last two weeks when my dad passed away in Tauranga. As a small to medium business owner for most of his life, Dad stood up for the underdog and had no patience for bad regulators or being ripped off by big corporations. As such, he should have endorsed this article. But he subsequently endorsed all of them, even those he disagreed with. R.I.P. Dad.
Disclaimer: Steven Joyce is a director of Joyce Advisory Ltd. His clients include Energy Resources Aotearoa and UK electricity retailer Octopus Energy.
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