Why NZ's electricity sector is a poster child for competition and climate action

COMMENT:

Behind your power bill and easy flick of a switch is a dynamic and evolving industry, which has introduced world-leading innovations, has been decarbonising for over a decade and is poised to cut New

Like many other everyday essential utilities, it's easy to take electricity for granted. We seldom associate the quality of life electricity provides with the industry framework behind it.

Our typical interaction with a power bill couldn't be described as inspiring. Yet behind those bills is a dynamic and evolving industry – one which has introduced arguably world-leading innovations, has been decarbonising for over a decade and is poised to cut New Zealand carbon emissions in many other sectors.

Poster-child for a competitive open market

The political decision to shift from the previous state-run generation model to a competitive one was controversial 20 years ago. But its proponents argued the major benefits would be downwards pressure on retail prices and much improved investment decisions, while the downsides considered were risks of reduced short-term coordination efficiency and a risk that there might not be sufficient spare capacity procured to offset New Zealand's extraordinarily volatile hydro inflows.

Although the market outcomes since then have been a regular topic of political reviews, the market has largely lived up to its original objectives and avoided tripping on the potential downsides.

"The recently released Electricity Price Review (EPR) and the Government response will make a number of changes, but once again has largely reaffirmed the effectiveness of the current model."

Advertise with NZME.

Despite the lack of central coordination, there hasn't been a repeat of the 1991 electricity supply crisis. Perhaps counter-intuitive, the lack of a common plan has made the sector far more capable of anticipating and recognising changes in outlook. Electricity companies do not rely on a political process to make decisions, instead acting on incentives to secure leads ahead of competitors.

At any given point in time the electricity sector might look stable and predictable, but over longer timeframes generation consensus can abruptly change, and has done many times. Early in the 2000s, the surprise re-determination of the Maui Gas field provided an early illustration of that dynamism, which saw generators swiftly adopt a new suite of growth strategies.

With demand still growing, the reversal of the previously expected plentiful gas required a shift to non gas-fired generation options. Political concerns that insufficient generation would be built to meet the growing demand proved unfounded.

The growth of renewables accelerated on their improving relative economics, and only one further efficient gas-fired generator was built at Huntly. The recent question mark over the continuation of Tiwai Point aluminium smelter presents another potential chance of significant change.

Whether a deal is done or the smelter closes, the long term outlook remains the same - electrification growth will start, and the cost of new renewable generation is likely to set the fair price for electricity.

Tiwai Point aluminium smelter presents another potential chance of significant change. Photo / Supplied

New Zealand's electrification opportunity is larger than Tiwai's load. So although smelter closure would likely lower prices across the country for three to five years, the electric conversion of other carbon-emitting industries should still be priced to reflect new renewables cost. This is despite the intuitive appeal of selling "surplus" power to large new conversion loads (such as dairy factories) at ultra-low prices.

A smelter-closure surplus period will be short-lived, so any such low-priced deals would more likely represent long term subsidies which would destroy value for sector investors.

The smelter's current contracts appear to be priced so low that its main supplier, MEL, is evenly poised between smelter closure (after which it would eventually receive undiscounted market revenue from its Manapouri generation) or the contract continuing unchanged. It has said Tiwai will need to offer concessions, such as extended contract term or longer termination notice, to agree to a lower price. It's not yet clear if the smelter is willing to concede on those contract terms.

Advertise with NZME.

Renewables now account for approximately 84 per cent of generation in New Zealand, up from 71 per cent 20 years ago. Many other economies are undertaking large investment programmes and forced imbalances in energy supply and demand, in order to achieve renewable targets that look modest in comparison.

New Zealand renewable growth has been achieved with minimal fuss and in the ordinary course of business, and has been subsidy free. Since market deregulation, roughly $10 billion is said to have been spent on new generation – most of which has been for renewables. This has of course been helped by the commercial reality that renewables are the cheapest form of new generation in New Zealand.

More renewables growth would have occurred, but by 2010 the industry outlook unexpectedly changed again, with demand growth suddenly stalling - and it's still lacklustre today. The industry reacted appropriately, completing already-committed renewables, and by permanently shutting down over 1,000MW of coal and gas-fired generation capacity.

The lack of cheap Maui gas in the early 2000s killed the prospect of cheaper power prices anticipated during market establishment. With demand growing, retail power prices climbed until 2013, due in large part to the higher cost for new non gas-fired generation to be built.

But the unexpected stalling of demand growth, plus growing competition from a field of innovative independent retailers has resulted in retail prices declining in real terms ever since.

Looking ahead, New Zealand's energy demand appears to be poised on the brink of further demand growth as carbon-intensive energy use in industry (e.g. coal-fired boilers) and travel (petrol and diesel) switches to low-carbon alternatives. Current forecasts for electrification of these energy uses would imply anywhere between 20 per cent and over 100 per cent growth by 2035, which might translate into between $2b and $4b of generation investment.

Fortunately, the generation companies look well-positioned to meet that investment, and shareholders are supportive.

"Roughly 95 per cent of New Zealand generation is listed on the NZX, and the sector is attractive to global investors due to its strong carbon reduction profile, good growth prospects, a subsidy-free renewable investment model and the characteristic high cash-flows produced by renewable generation."

The listed electricity companies are optimistic and have reactivated their project options, in hibernation since early this decade. Two new windfarms have been committed in the last six months, with a third

windfarm and new geothermal station looking likely to reach commitment within the next six months. Together these would represent about 5 per cent of current demand, lifting New Zealand renewables' share of electricity towards nearly 90 per cent. The Interim Climate Change Committee's recent report estimated a 93 per cent renewable electricity share by 2035, even under its "business as usual" forecast.

But demand still hasn't appreciably risen since 2010, and a "build it and they will come" approach has historically been a poor decision. So after these new projects proceed, major generators seem unlikely to follow up with further commitments until they see tangible increases in demand. When that does eventuate, generation companies appear enthusiastic and well-prepared to extend their renewable build programmes further, with wind, geothermal and perhaps solar investments.

Will prices need to increase for this new investment?

The jury is out on whether prices will increase. The latest batch of wind farms and geothermal stations are far cheaper than 10 years ago and much cheaper than the wholesale forward price we observe today.

But New Zealand generation does have to face the same reliability question posed in other countries.

New Zealand is far better placed to deal with wind variability due to our large hydro fleet and some spare thermal capacity which can run to firm up renewable shortfalls. But when called upon, such backup generators will require higher prices than today.

Whether prices rise or fall on average will therefore depend on how often those backup stations need to generate. But there is good reason to be optimistic that the lower cost of renewables will be the dominant driver of prices, and result in overall lower electricity prices in the future.

• This article reflects the opinions and views at the time of publication, and is not to be relied upon as a basis for making any investment decision.