Hedge Markets and Vertical Integration in the New Zealand Electricity Sector: A Report for Contact Energy

12 October 2004
By Graham Shuttleworth and former NERA Consultant Tim Sturm

Since 1998, the New Zealand electricity industry has exhibited a high degree of vertical integration. Some commentators have suggested that vertical integration hinders the use of contracts to hedge risks and that vertically integrated companies should therefore be forced to offer "hedging contracts," which specify the future price at which electricity will be bought or sold.

In this report for Contact Energy, NERA Director Graham Shuttleworth and former Consultant Tim Sturm review the arguments raised against vertical integration and in favor of compulsory hedging by New Zealand electricity companies. They examine the reasons why companies choose vertical integration, rather than relying on contracts, and they discuss the difficulties that compulsory hedging would create. They find that vertical integration is often an efficient response to competitive conditions and that the liquidity of markets for "hedging contracts" is limited by the underlying market conditions in New Zealand, rather than by vertical integration alone. They conclude that proposals for compulsory hedging are unlikely to achieve the desired outcome and may even harm efficiency.