Lobbying for regulation is a required aspect here, I agree – as otherwise (as a natural monopoly) the wholesaler wouldn’t have to worry about entry or punishment. Without another supplier of power, the buyers can’t commit to a grim trigger.

I’m not even sure if we could necessarily have a better form of market – maybe we could – but maybe we couldn’t. The spike in itself doesn’t change my view, or the information available to me regarding that. It will change the belief structures of buyers – we might see more fixed term contracts as a result – but it hasn’t changed the fundamentals the industry was based on.

Fair call – it is an interesting issue. I hope that industrial economists are going to have a bunch of fun thinking about it.

@Miguel Sanchez

“I’m not clear what “empirically false” means in this instance. Theory tells us what people should do, under a tightly defined set of conditions. If that’s not what people actually do, then it tells us which conditions we should be looking at.”

Perfect call – showing it does match the data tell us that either one of our core assumptions is false, or that one of our auxiliary assumptions is both false and actually a core part of the model.

“In this case, the “grim trigger” seems like a credible threat on the face of it”

This is the kicker, a grim trigger isn’t really a “credible threat” unless you can come up with a pre-commitment mechanism. It is sensitive to “trembling hands” – such that a mistake could throw us out of it. As a result, without some sort of observable “precommitment mechanism” this equilibrium would likely be too unstable to be relevant.

However, you are right that the idea of trigger strategies – and the implied “stock of reputation” does have appealing properties for what we are looking at here. Within that context, it is understandable why a generator would make spot prices less variable than fundamentals would suggest. And it also points out that there is something strange about this specific situation – something else that we should look for rather than bemoaning competitive pressures as a catch all term.

So I don’t disagree with your use of such things here, I’m just nervous about relying strictly on the grim trigger too much – for example I would rather prefer to look around for things like the threat of potential competition/regulation as a limiting factor on price in this case.

I’m not clear what “empirically false” means in this instance. Theory tells us what people should do, under a tightly defined set of conditions. If that’s not what people actually do, then it tells us which conditions we should be looking at.

In this case, the “grim trigger” seems like a credible threat on the face of it – the buyers could ostracise Genesis and eventually drive them out of business by not dealing with them in the future, even though that would come at the cost of having to pay more for power from elsewhere. But maybe they can’t do that? And it still doesn’t answer the question of “why now” – has something changed to make the grim trigger less credible? I don’t know enough about the structure of the electricity market to say.

I agree that Genesis have actually done both regulators and the demand side a huge favour by demonstrating to them that there are real risks in the NZ electricity market. It’s now crystal clear that you can either pay a predictable higher price to mitigate that risk, or you can take a lower price and live with the risk – in which case, you’ve no right to moan when the risk happens and you lose. Or the regulators can prevent supply side from profit-making at times of shortage, in which case they should not be surprised if the supply side declines to invest in the capacity to cover such times (California).

Of course it’s true that the risk was always there. But my case was that the demand side had understandable cause to discount it – because previous experience had shown them that the supply side would act with public-spirited self-restraint in such circumstances. It would be interesting to know why the supply side didn’t on this occasion. Have Genesis recently appointed Montgomery Burns as Chairman?

“Seems the buyers weren’t on fixed price contracts because they had been lulled into a false optimisim”

This isn’t policy relevant – they took on the risk, it is really their own fault if their belief structure was poor.

“The question then is really, why had they been lulled into a false sense of optimism? Given the physical and topographical nature of this market, this can’t be the first time a generator has found itself in a position of temporary local monopoly – why hadn’t they been taking advantage, and so educating the demand side into more realistic expectations?”

Surely the knowledge they now have, that prices can spike, is sufficient information for them. If they suffer from a spike in the future, it is their own fault – again why don’t they go onto a fixed term contract if it pains them so.

We can’t regulate on the basis of “expected irrationality”.

@Miguel Sanchez

The old grim trigger. I am under the impression that isn’t a particularly popular strategy to study anymore because it appears to be empirically false.

If it was an issue of reputation that kept spot prices now, it is very weird that they suddenly lifted the price at that one point in time without considering reputation. Overall, I am not sure how much I trust the description of the situation from any of the market participants – they are really just all speaking with their own interests at heart.

And I still can’t believe the no-one will ask them why they didn’t use fixed price contracts if it is such a big, concerning, risk 😛

The question then is really, why had they been lulled into a false sense of optimism? Given the physical and topographical nature of this market, this can’t be the first time a generator has found itself in a position of temporary local monopoly – why hadn’t they been taking advantage, and so educating the demand side into more realistic expectations?

This is all fine, it is perfectly fine to say there is a competitive issue that needs to be investigated – in which case any regulation is at least justified rather than arbitrary.

However, even within this context I STILL have the question “why weren’t these people on fixed price contracts”. They are complaining about the price spiking because they lost a bet on what spot prices would do – I can’t have much sympathy with that.

As a result, this is the first question I’d ask myself before looking at the issue in any sort of detail.

What seems to me to be inexplicable here therefore, is not that Genesis took advantage of their temporary natural monopoly this time – it is that the same sort of behaviour doesn’t happen all the time. In fact it seems to me to be quite dangerous that it doesn’t, for it encourages politicians and market participants to base their approach on the assumption of public spirited self restraint by those in a position to make a killing. It’s a lovely idea, but sooner or later you’re going to get killed …