Everywhere you look there is evidence of lower economic activity. Retail spending, housing, capital spending, hospitality, even the number of cars on the road in the morning commute. All are well down.
The economic data, late though it often is, confirms what we all see and feel. Just yesterday came confirmation that concrete production, an important indicator of activity, is down around 10% year on year. In some sectors, people are starting to compare the current environment to 1987.
To that extent, monetary policy is working. The Reserve Bank is throttling us back to correct the policy excesses of the Covid period. It doesn’t make it any easier to cope with that the same governor who helped create the mess is charged with cleaning it up, but that’s another story.
The key question is whether he and his bank will make the right calls on when to reduce interest rates, and not overshoot and drive the economy into the ground. We’ll learn more next week.
To the extent our economy currently has a pulse, it wouldn’t take much additional pressure to stall it altogether.
Even a moderately sized black swan event could have a major impact, and business owners will be nervously scanning the horizon. There is plenty you could worry about, like the Chinese economy, a meltdown in world stock markets (which almost happened this week), or full-scale war in the Middle East. But there is an issue materialising much closer to home which should have the Government very concerned.
The New Zealand energy market has been a slow-moving train crash for some time, but it is getting worse. Prices are skyrocketing, spot prices are ridiculous, consumers are hurting, electricity retailers are abandoning the market and major industrial users around the country are cutting back their operations. All of this will only heap downward pressure on wider economic activity.
The energy sector has been treated as a political plaything over the past six years. The Ardern Government’s abrupt oil and gas exploration ban had a hugely chilling effect both on the gas industry and international investment more generally. With that one captain’s call, New Zealand’s sovereign risk escalated hugely, and our reputation as a predictable place for people to invest and grow jobs was kicked to the kerb.
And that wasn’t all. The ill-fated decision to pursue the Onslow dam put a further chill on generation investment in the electricity sector. Who wants to punt several hundred million dollars on a generation plant when the Government is threatening a huge government-owned gorilla which does not have to be justified economically, and which may be priced to completely undermine your investment? It is no surprise many other generation projects went into hiatus.
Of course, those issues are now in the rearview mirror. The question is what the current Government will do to solve the problems we have now. These include low ongoing levels of electricity generation investment and electricity pricing which is the highest in the Western world.
The two issues are at one level counter-intuitive. Traditional economic theory says higher prices mean excess demand, which encourages more supply to be introduced. The reason that is not happening here is likely to be market structure.
In New Zealand, electricity generators are allowed to operate retail businesses, and they are currently permitted to manage pricing between those two arms in a way that can make it hard for new competitors to turn up.
Recent experience shows it is almost impossible for new retail companies to succeed in this market because, on current pricing, gentailers choose to make their money on 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 customer bases to sell electricity to.
The net effect is our current gentailers largely have the field to themselves, and they are doing nicely, thank you. It is in their interests to sweat their existing assets for as long as possible and only build new generation on the margins.
All this has remarkable echoes of the vertically integrated Telecom New Zealand, which worked very hard to maintain its structural advantages and sweat its old copper phone network rather than build out fibre to the home.
It was the then Government’s ultrafast broadband programme, which yours truly had a bit to do with, which encouraged Telecom to break into Chorus, the infrastructure arm, and Spark, the retailer, and build out the fibre. There has been strong competition in the telecommunications sector since then.
If all this is largely known, what are the regulators doing about it?
One problem is we have two regulators involved. The Commerce Commission, which seems more concerned about the international sale of small tech companies than the state of one of our most important industries, and the Electricity Authority (EA), whose approach to electricity market regulation is almost supine. The two of them are standing at the regulatory door like two old gentlemen saying “after you”. In telecommunications, the commissioner and his powers are part of the Commerce Commission.
The EA itself seems confused about what the problem is and how to solve it. It has written a bunch of reports on the issue and made a few ineffective regulatory steps, but inertia seems to be its middle name. No wonder Shane Jones called it a “chocolate teapot” this week.
Ministers do seem to be awake to the risks. Energy Minister Simeon Brown is starting to pile up the pressure for the EA to act, but it’s not clear it knows how. Politically we are fast approaching the point where simply prodding the EA won’t be enough.
There is a range of regulatory tools available, from transparent pricing between the gentailers’ generation and retail arms which is available to all, through to operational separation, or full structural separation, which is the most drastic. They have all been tried in a range of countries with significant success.
Clearly, someone needs to act to both bring down prices and increase generation. If the regulators won’t then the Government will have to. We can’t have our economy further nobbled by the structural failings of our most important utility industry.
In closing, this column lost probably its most avid reader in the past fortnight, with my Dad passing away in Tauranga. As a small to medium business owner most of his life, Dad stood up for the underdog and had little patience with poor regulators or being squeezed by big companies. He’d therefore have approved of this article. But then he approved of all of them, even the ones he disagreed with. Rest easy Dad.
Disclaimer: Steven Joyce is a director of Joyce Advisory Ltd. His clients include Energy Resources Aotearoa and Octopus Energy, a UK-based electricity retailer.
