The Commerce Commission has concluded its principal investigation into whether any participants in the wholesale or retail electricity markets may have breached Part 2 of the Commerce Act. The Commission has found no evidence of breaches of the Act, although it will be issuing one warning regarding a risk of a breach.

The investigation was opened in late 2005 after a number of complaints about high electricity prices, large company profits, a perceived low level of competitive activity and allegations of anti-competitive conduct.

The investigation focused on whether the vertically integrated generator-retailers (also known as gentailers) had market power and, if so, whether they had taken advantage of market power in breach of section 36 of the Commerce Act; and whether they had behaved in a collusive manner in breach of sections 27 or 30.

The section 36 part of the investigation included an economic analysis of the wholesale market undertaken on the Commission's behalf by an internationally renowned expert in the field, Professor Frank Wolak of Stanford University. Professor Wolak is widely published in this type of market study and is also the Chairman of the market surveillance committee of the California Independent System Operator.

Professor Wolak's work is based on an analysis of data relating to the New Zealand wholesale electricity market for every half-hour period for every day from January 2001 to July 2007, amounting to millions of datapoints. This is the most comprehensive set of data about this market that has ever been assembled.  The Commission also obtained and analysed company documents, and interviewed major parties in the electricity industry.

"The Commission considers that each of the four largest gentailers - Contact, Genesis, Meridian and Mighty River Power - is likely to have held substantial market power on a recurring basis, particularly during dry years," said Dr Mark Berry, Chair of the Commerce Commission.

"Each of these companies has the ability and incentive unilaterally to exercise market power and increase wholesale prices during certain periods.  The price increases in dry periods are well above any increases in input costs, including the higher opportunity cost of water when hydro storage is low.  However, the Commission concludes in the case of this investigation that the gentailers are using that market power to maximise their profits in a purely legitimate way within the current market structure, design and rules. The Commission has found no evidence of an anti-competitive purpose," said Dr Berry.

This behaviour does not meet the criteria of 'taking advantage' of market power for a proscribed purpose, namely the hindering or deterring of competitors, under section 36 of the Act, and is therefore not a breach.

By comparing the actual wholesale prices with hypothetical competitive benchmark prices, Professor Wolak estimated that the wholesale prices charged over the period 2001 to mid-2007 resulted in an extra $4.3 billion in earnings to all generators over those that they would have earned under competitive conditions.  This suggests that wholesale prices were, on average, 18 per cent higher than they would have been if the wholesale market had been more competitive, and the gentailers had not been able to exert market power.  Less competition was especially evident in the wholesale market during the dry years of 2001 and 2003, when additional earnings attributable to the exercise of market power are estimated at $1.5 billion in each of those years.

"The extent to which these peaks in wholesale prices have been passed on to consumers over the seven year period is difficult to estimate, although retail prices have followed a strongly rising trend.  We consider that pass-through of wholesale market power rents to retail prices is likely to have occurred with a lag, but it has not been necessary in the context of this investigation for the Commission to determine this," said Dr Berry.

The Commission's investigation also considered whether the gentailers had colluded to lessen competition in the wholesale or retail market, thus breaching sections 27 or 30 of the Act. The Commission found that Trustpower may have been at risk of breaching section 27 of the Act in 2004 and is accordingly issuing a warning to that company. Otherwise, the Commission found no evidence of collusive activity, although one specific and limited event continues to be investigated by the Commission. No further information regarding this event can be provided until the investigative activity and analysis is concluded.

Further, there has been no finding of a breach in the retail sector under the investigation to date and therefore there is no basis for the Commission to make further assessment of the retail market or the effects of vertical integration.

"Nor does the Commission consider that it is appropriate at this stage to initiate an inquiry under Part 4 of the Commerce Act," said Dr Berry.

The Commission considers that the issues raised by the investigation within the context of New Zealand's vertically integrated electricity market structure are most appropriately addressed by other parties. The Commission recognises that its investigation is likely to be material to the Ministerial Review of the Electricity Market, announced last month by the Energy and Resources Minister, Gerry Brownlee.

The Commission is releasing both its full investigation report, and the report of Professor Frank Wolak, under the provisions of the Official Information Act in response to a number of requests.

The full report is available on the Commission's website.