Vertical integration trends

Report notes

1. Reconciled sales and purchase volumes are used to construct a simple measure of vertical integration (VI) in the wholesale electricity market. Vertical integration may enable a business to achieve efficiencies by lowering costs. For example, VI might be an effective risk management strategy for some firms. Trends in vertical integration through time are therefore a useful way to observe how different firms arrange their business activities.

2. In this report, the degree of vertical integration extends only to energy sales (injections) by generators or their agents and purchases (offtake) by retailers. Complete forward or backward integration of the entire supply chain beyond the wholesale energy market is not considered, as the VI measure is concerned only with the physical market for electrical energy. Positions in derivative markets and other financial hedging arrangements are ignored.

3. Reconciled sales and purchase volumes are drawn from the monthly reconciliation data report (GR-010) produced by the reconciliation manager. In addition to the volume-based measure of VI, a value-based measure is also constructed by multiplying the volumes by the relevant half-hourly final energy price published by the pricing manager.

4. Both the volume (MWh) and value (Dollar) measures are also expressed as a percentage. Zero per cent represents a firm or group of firms that is completely vertically unintegrated whereas 100% represents complete vertical integration.

5. If a firm, or trader, has total purchases that precisely equal its total sales, we say that sales and purchases are matched. If total purchases exceed total sales then only a portion of the trader's purchases are matched by its sales, and vice versa. In other words, if S denotes sales and P denotes purchases, the matched volume is equal to min(S, P). The VI measures expressed as a percentage, whether volume or value, are defined as: 100·2·min(S, P)/(S + P).

6. The VI measure can be viewed over any date range from 1 January 2005 until the end of last month. At a regional level, the measure can be calculated for all of New Zealand or at the island level. The VI measures are calculated on a monthly basis, although if a date range of less than two years is selected, the option to calculate the measures at a daily resolution becomes available.

7. The black triangle at 1 June 2011 on the horizontal axis depicts the date at which the government-enforced sale by Meridian of the Tekapo A and B hydro stations to Genesis took effect.