Brian Fallow 's Opinion

The Economics Editor of the NZ Herald

Brian Fallow: Manapouri power vital resource

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As  Meridian would be a net seller of power on the wholesale market it would also have an interest in keeping prices there as high as possible. Photo / NZH
As Meridian would be a net seller of power on the wholesale market it would also have an interest in keeping prices there as high as possible. Photo / NZH

Having announced that the Tiwai Point aluminium smelter most likely has about another five years to live, Prime Minister John Key tried to put a positive spin on it.

Over the long run an orderly exit of the smelter would mean that the power it consumes could be used by new ventures, he said.

Or it would allow less productive generating assets to be closed down.

Or we would need to build less generation.

It sounded like the regurgitation of a briefing from officials trained to think in the airy abstractions of economists, about "resources flowing" to new and more valuable uses, about "creative destruction".

In practice, a lot of the resources are likely to take the plane to Brisbane or Perth.

Apart from its highly skilled workforce, the other big resource employed in the smelter is the power that flows down to it from Fiordland.

If the release of all that cheap electricity from Manapouri enabled the revitalisation of the pulp and paper sector, say, so that some value was added to logs we export raw, that would be one thing.

But we seem to be incapable of getting our national act together for projects like that.

And it's hard to see the need to build less generation as an unalloyed good.

One official told me that, if freed of the need to spend money on new generation projects, the state-owned power companies up for sale would just "throw off cash for years". The image of a sodden shaggy dog came to mind.

But in that case, why sell them?

And surely there is a risk that if there is a long delay before new generation needs to be built we will lose the people who know how to build it. How secure is Mighty River's vaunted expertise in geothermal if all the opportunities are overseas?

There seems to be a widespread assumption that the closure of the smelter would be hard on Southland but good news for the rest of us by way of cheaper power.

And that would mean lower profits for the power companies and less money for the Government when they are floated.

But that narrative rests on a simplistic view of electricity sector.

This is no ordinary commodity. It is not like a glut of apricots, driving down the price.

What there would be a surplus of is generating capacity, not electricity itself.

Some surplus capacity is normal and desirable. The system needs a security margin to cope with dry years, like this one.

But not as much of a surplus as would arise from a 14 per cent contraction on the demand side and no change on the supply side.

So when people like the Prime Minister talk of an orderly transition to a post-smelter environment, they are talking about the scrapping, or mothballing, of more expensive generating capacity.

Genesis Energy's four coal-fired turbines at Huntly are obvious candidates. That process is already under way and its acceleration is now on the cards.

But even with all its units operational Huntly's coal-fired plant in recent years has only been generating the equivalent of about 40 per cent of the smelter's load.

More supply-side contraction than that would be needed.

Which is why the eyes of analysts, and the power companies' in-house modellers, swivel towards gas-fired plants, most of which belong to Contact Energy or Genesis.

If Manapouri's power flows north instead of south, that will reduce the average cost of generating the power you and I consume.

But in the wholesale electricity market it is the marginal cost, and not the average cost, that matters.

In any given half-hour it is the most expensive generation that needs to run in order to ensure that all the demand is met which sets the spot price which all the generators dispatched receive.

So a key question is how much less of the time would one of the combined cycle gas turbine plants - Contact's Taranaki and Otahuhu B plants and Genesis's e3p at Huntly - be the marginal generator that sets the price.

And what would the volumes going through the market at those times be?

Faced with the prospect that these plants will run less, both companies might take the view that they need to recoup their fixed costs over a smaller volume and therefore offer that power to the market at a higher price.

And as Meridian would be a net seller of power on the wholesale market it would also have an interest in keeping prices there as high as possible.

This does not sound like a recipe for lower prices for consumers.

Alternatively we could see a period of cut-throat competition at both the wholesale and retail levels, as the companies fight for a bigger slice of a smaller pie.

It is that sort of uncertainty the institutional investors who will set the price for Mighty River shares, and those that follow, will have to factor in.

The Manapouri power station is an asset of national importance and an impressive piece of engineering.

Rain that falls in Fiordland - and usually there is a lot of it - flows first into Lake Te Anau and thence into Lake Manapouri. It used to then flow down the Waiau River to Foveaux Strait, but most of it now drops in one go to sea level at Deep Cove via turbines in the middle of a mountain.

The smelter was built, more than 40 years ago, to provide a use for that power.

"We used to say it was a way of exporting water," a senior industry figure told me. "Now it's a way of exporting gas."

His point was about the opportunity cost to the country of the smelter's pre-empting Manapouri's output, including the need to convert one premium form of energy, natural gas, into another, electricity, using up about half of it in the conversion process.

The smelter's closure will leave a large hole in the country's external accounts.

In the year to June last year it turned $280 million worth of imported alumina into $1.14 billion of exported aluminium. It also has to import petroleum pitch to make carbon anodes, but it is hard to see its imported inputs offsetting more than 40c in the dollar of its export income.

This is not an argument for a long-term subsidy for the smelter.

But it is essential now that the valuable resource freed up by its closure be used in ways that help the country earn its living as a trading nation, and not frittered away making it marginally cheaper to run the dishwashers and neon lights of Auckland.

- NZ Herald

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Brian Fallow

The Economics Editor of the NZ Herald

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