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Bryan Leyland

The Future of Electricity Supplies in New Zealand

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The New Zealand electricity market has given us ever increasing prices and there is an increasing risk that a dry hydro year could lead to extremely high prices and blackouts. Major changes to the industry are needed – and quickly.

There is growing evidence that the market has failed to provide a reliable and economic supply.

Transpower’s 2017 review of system security – based on an optimistic assessment of peak demand and the ability of thermal generators to make up the dry year shortfall – is sobering. It warns of an increasing risk of short blackouts whenever there is insufficient generation to meet peak demand and much longer blackouts due to lack of hydro generation in a dry year.

The risk was high a few weeks ago but has reduced since then due to heavy rain in the hydro catchments. Even so there is still some risk because Tekapo B station is out for maintenance, snow pack is unusually low, Huntly does not have enough coal on its stockpile and we don’t know how much extra gas is available.

Residential electricity prices increased by 52% after adjustment for inflation between 1996 (when the market started up) and 2017. Before the market we had lower prices than nearly all developed countries: we are now in the middle of the range. Why?

Over the last nine months, spot prices have been well above normal so we can expect higher prices next year. A major reason is that the market pays the same price to low-cost hydropower generator that it does to high cost thermal generation. This results in windfall profits for the hydropower generators that generate 65% of our power. An additional contributing factor is the Emissions Trading Scheme that jacks up the cost of generating power from coal and gas. As these stations often set the price that all generators get the hydro and geothermal stations make additional windfall profits. For every million dollars paid in carbon tax, the consumers could pay millions more to the renewable generators. 

The lines companies operate under a Weighted Average Cost of Capital (WACC) regime. If they can build something new and pay less for their money than WACC, they make money. Before the electricity market they all operated ripple control systems that limited the maximum demand and saved the consumers millions of dollars. The market regime prevented them from recovering the cost of operating, maintaining and extending their ripple control systems. So most of them abandoned ripple control, increased their peak demand and made money from the additional capital expenditure to meet the higher demand. Also, when they were set up they promptly revalued the assets that the consumers had already paid for and charged consumers even more.

The retailers add another layer of bureaucracy and cost from playing “dog eat dog” with the consumers and deploying very expensive smart meters that have been very little benefit to the consumer. As one bit of electricity is exactly the same as any other, it is hard to see what useful purpose the retailers perform.

In the days before the electricity “market” the primary task of the power planners was to minimise the total cost of generation and transmission and ensure that the lights did not go out in a dry year. (A dry year is usually defined as 1:20 dry year when hydropower generation drops by 3600 GWh – about 10% of total New Zealand generation.) According to market proponents, dry years are no longer a problem. I am not convinced.

Several new geothermal stations have helped to provide an adequate amount of generating capacity for a year with normal rainfall and the coal fired Huntly station is seldom needed. However, if we want to keep the lights on in a dry year the gas and coal fired stations might need to increase output by 70% above normal for a period of four months or more. This is no trivial task. 

Wind power cannot help because its output is unpredictable and records show that, on average, its output drops by about 10% during the autumn and winter when we need it most. The situation may be even worse than that because wind output dropped by about 40% during the dry period last year. So increasing wind power capacity will increase the need for backup energy in the autumn and early winter.

Solar power makes the situation even worse because its output is greatest during the summer, least in the winter and zero at night. 

Geothermal can only help to a small degree because most geothermal stations run flat out continuously. Also, most geothermal fields will not tolerate fluctuating outputs and their environmental consents usually prescribe that they must operate at a steady take from the field.

In the 1992 drought a large amount of extra gas was taken from the Maui field. None of the current gas fields can supply much extra gas and, even if they did, the throughput would be limited by the gas processing plant. Nevertheless, some extra gas could be produced and, if the price is right, the methanol plant might shut down and make some more available. It appears that gas reserves are declining rapidly so the situation will soon be much worse – especially if the government caves into pressure from the Green Party to limit gas exploration and drilling. 

Many people seem to believe that batteries can solve the problem but the economics of having say, 2000 GWh of batteries costing about $2 billion on standby and fully charged just in case a one in 20 dry year comes along, are not attractive. Not only are the batteries seriously expensive but their life might be less than 20 years. The power extracted from them could cost more than 100 times as much as domestic consumers pay right now.

It would be possible to mitigate the risk by keeping the storage lakes brim full from January to May in all years with normal rainfall. The disadvantage is that this would result in a massive increase in spill in normal and wet years and would require additional generating capacity in the rest of the system to make up the loss from spilling.

Another option is to build a large pumped storage scheme. A site has been identified in the South Island that could store sufficient energy to get us through a dry year. But it would be expensive and it would take at least 10 years to build. RMA consents alone would probably take five years because they are likely to be opposed by environmentalists.

The inevitable conclusion is that the coal stockpile at Huntly is the major source of additional energy for the next 10 or 15 years. If Huntly kept two or three 250 MW sets available and kept 1 million tons of coal on its stockpile, it would probably be sufficient to keep the lights on during a dry year.

A major problem with the Huntly option is the government’s ambition to shut it down.

There is another problem for both pumped storage and Huntly: the electricity market does not compensate the owners for the high annual cost of keeping large amounts of energy and associated capital investment in reserve for a low probability event.

The Electricity Authority believes that retailers will all think long-term and buy sufficient hedges to minimise their risk in a 1:20 dry year. In reality their time horizon is about three years so they don’t buy long-term hedges. This problem could be solved by making them purchase the coal they needed and pay Genesis the cost of turning it into electricity when the time came.

To make money, a pumped storage scheme needs to be able to pump using cheap electricity and generate when the price is high. If the price was low and the pumps started up, the extra demand would immediately jack up the price: the owner of the pumped storage scheme would never get access to cheap electricity. The lake would be full of very expensive water that might be needed once every 10 or 20 years. Under the present market regime, no rational generator would contemplate such a development.

Huntly has much the same problem. At the moment, it has the 230,000 tons of coal on its stockpile that it needs to meet its contractual obligations. But to provide dry year insurance for the economy, it needs about 1 million tons of coal which is probably worth $150 million.

If New Zealand Inc wants to avoid blackouts, then it must consider buying insurance by compensating Genesis for the $15 million or so annual cost of maintaining the coal stockpile and millions more for keeping the station on standby. There is no chance of this happening at the moment because the Electricity Authority will not contemplate annual payments – and if they did, the environmentalists would have a fit!

I don’t think the industry will take the lead in solving the problem because, as two departing CEO said, the gentailers maximise profits by keeping New Zealand on the edge of a shortage and racking up the spot price. We can’t expect generators that are making windfall profits from the electricity market to tell the government that the current electricity market is flawed and something needs to be done about it. Why kill the golden goose?

But something must be done to minimise the ever increasing cost and risk. A group of people experienced in the New Zealand power system and economic analysis could be convened and told that their objective is to find the best way of providing a reliable and economic supply for New Zealand in the long term. They would consider all credible options and report on the economics, advantages and disadvantages of those options that could mitigate or solve the problem. 

The final decision would be made by the politicians – as it should be. And if they got it wrong and there were blackouts they would probably lose the next election. That just might get their attention!