The government will spend $30 million to investigate a potential $4 billion hydro scheme in Central Otago to reduce the need for coal and gas-fired generation in dry years and create jobs in the wake of the Covid-19 pandemic.

Energy and Resources Minister Megan Woods said the funding will investigate a range of pumped hydro options around the country, but its main focus will be on testing the business case for a project at Lake Onslow, south-east of the Roxburgh dam operated by Contact Energy.

If built, the project would be the first major hydro project since the construction of the Clyde Dam and Lake Dunstan, in the 1980s.

The Onslow scheme, promoted during the past two decades, would create the country's biggest hydro storage lake with an estimated 5,000 gigawatt-hours of power production. All the country's current hydro schemes combined can store about 4,500 GWh.

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While much of the project's benefit comes as a straight generation project, an accompanying pumping system to return water to the lake and keep it high for potential dry periods could make it an effective insurance against the dry periods the country experiences every five to six years. New Zealand relies on hydro for more than 65 per cent of its electricity generation.

"A project like Lake Onslow is ambitious," Woods said in a statement. "It would be the single biggest infrastructure project since the 1980s. That's why it's important to get certainty on the costs, logistics and any environmental impacts of what would be a game-changing, long-life asset for many NZ generations to come.

"The $30m allocated will pay for the detailed development of a business case for a solution to address New Zealand's dry-year storage problem. This analysis will mostly focus on a pumped hydro storage project at Lake Onslow in Central Otago, but will also include the assessment of smaller potential pumped storage options in the North Island, as well as other alternative technologies."

Pumped hydro systems are used internationally but tend to be relatively small. They are usually used more for general generation reasons or for meeting peak demand for power or irrigation.

In Australia, which still makes more than 70 per cent of its power with coal and gas, the federal government is planning to add pumped storage to the Snowy Hydro scheme at a cost of about A$5.1b ($5.4b). It will provide just 350 GWh of storage.

Meridian Energy has previously investigated pumped hydro on its Waitaki system but never found it viable. Other smaller schemes on the North Island have also been investigated.

Today's announcement is a belated response to the April 2019 report of the Interim Climate Change Committee, which had recommended the government drop its 100 per cent renewable electricity generation target and instead focus on greater electrification of transport and industry to get economy-wide emissions down.

The committee found that, through to 2035, relatively low cost and low-emission natural gas would remain the best option for managing dry-year risk.

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But it recommended priority be given to further investigation of pumped storage as a longer-term replacement.

Based on the Lake Onslow proposal, the committee estimated such a scheme would cost about $250 for each tonne of carbon dioxide avoided, less than half the cost of paying large industrial power users to halt operations during dry periods and less than a third of the cost of running biomass-fired generators to cover that hydro shortfall.

The cost of hydrogen-fuelled back-up generation was estimated at $1,500 per tonne of CO2. Deliberately over-building wind, solar and geothermal capacity – the government's preferred option - to manage dry-year risk was not much cheaper at $1,270 per tonne of CO2.

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The committee also noted that deploying a range of smaller projects across a range of technologies may prove more cost-effective and socially and environmentally acceptable.

But the announced closure of the Tiwai Point smelter – which uses about 12 per cent of the country's electricity - will leave the country awash with surplus electricity for several years. . That is also likely to hasten the departure of the large coal and gas-fired generators New Zealand has typically relied on for electricity generation in years when hydro lakes are low.

Meridian has also announced its intention to lay additional rock armour in the bed of Lake Pukaki, its biggest hydro reservoir. That work will be done during the next dry spell and by itself will enable an extra 545 GWh of generation during dry periods.

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The government had originally been aiming to respond to the committee's recommendation on pumped hydro by December last year.

Today's announcement indicates the $30m initial business case could be completed some time next year. Subject to that work, a further $70m could be spent in 2022 undertaking preliminary engineering, environmental and seismic studies.

While no decisions have been taken to proceed with any construction, material with today's announcement suggests the government thinks construction could start as soon as 2023.

And even if nothing is built, the government will have advanced long-term planning for lower-carbon generation and created short-term jobs as part of its Covid-19 response.

Woods estimated that "hundreds of jobs" would be created from the business case phase of the work alone.

"Construction of such a project would create further significant employment. For example, the full Lake Onslow project at its peak could employ 3,500-to-4,500 skilled and semi-skilled workers, as well as thousands more in indirect jobs."

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Funding for the work is from a tagged $3b contingency the government created for infrastructure projects in the May budget.