Market Power Misdiagnosed

The closure of Hazelwood Power Station removed a significant amount of generation capacity from the National Electricity Market (NEM). A recent report by Bruce Mountain and Steven Percy concludes that large electricity generators exploited the closure to exercise market power.[1] The authors claim that this was blatant price gouging that left electricity consumers nearly $3.5 billion out of pocket. Federal Energy Minister, Angus Taylor, immediately seized on the research as support for his “Big Stick” legislation, which would introduce draconian interventions in the NEM, supposedly to end “abuse of market power.” A previous bulletin from Frontier Economics examined this legislation.

Misdiagnosis?

How accurate are the authors’ claims? Is this the best explanation for the effects of the closure? These questions are critical as bad government policy should not be lent credence by equally bad ‘evidence’. Our review reveals that Mountain and Percy reached the wrong conclusions due to fatal flaws in their analytical approach. This bulletin sets out why.

The Mountain-Percy report concludes that prices rose in the Victoria and NSW regions of the NEM between 2016 and 2017, coinciding with the closure of the Hazelwood coal-fired generator. There are several potential explanations given for the observed price rise, including:

• Increases in demand
• Reductions in supply following increased market power allowing generators to profitably raise their bids
• Reductions in supply as a direct consequence of the highly used 1600MW Hazelwood coal-fired generator exiting the NEM and no longer supplying
• Other events, for example outages or rising gas prices.

Mountain and Percy attribute the price increases entirely to the most headline-grabbing explanation—price-gouging due to the exercise of market power. By doing so, they ignore more obvious and plausible explanations, such as a material physical reduction in supply. Economics 101 tells us that a reduction in supply tends to result in an increase in price – with no exercise of market power and no ‘gouging’ at all.

Extraordinary claims require extraordinary evidence. However, we show that the ‘evidence’ adduced by Mountain and Percy is extraordinarily flawed.

To continue reading this bulletin, click the button below.

[1] Mountain and Percy, The exercise of market power in Australia’s National Electricity Market following the closure of the Hazelwood Power Station, Victoria Energy Policy Centre Working Paper, March 2019 (the Mountain-Percy report).