Government plans to target emissions in the electricity sector have sparked warnings, writes Brian Fallow in the second of a four-part series.

Key Points:

The aggressive reduction in carbon emissions from the electricity sector envisaged by the Government's energy strategy would ramp up power prices and imperil security of supply, Genesis Energy says.

In its submission to the climate change discussion documents issued by the Government late last year the state-owned generator said electricity prices would have to rise by 2.5c or 3c a kilowatt hour to deliver the steeply falling emissions profile the energy strategy outlined.

And the trade-off between reduced emissions and security of supply was stark, it said.

"A good theoretical case can be made for polluters to bear the cost of pollution. But it is important not to rush headlong from theory to practice."

Genesis interprets the energy strategy as envisaging the premature closure of its coal-fired Huntly plant by 2015, about 10 years before the end of its design life.

But replacing Huntly's 1000MW - 11 per cent of the country's generating capacity - would take some doing, especially if the replacement was wind power which is only available some of the time.

Genesis is dubious of the strategy document's assumptions on the cost of renewables.

Strong global demand for wind turbines has bid up their price, and when the exchange rate falls that will make them more expensive.

Genesis also notes hidden costs for renewables, such as increased investment in the national grid and the need for reserve capacity, and the delays and difficulties in getting renewable projects consented.

It might be possible, given favourable commercial conditions, for renewables to cope with growth in demand for electricity, it said, but even that would imply an uptake of renewables well above that seen to date.

Climate change itself might pose a risk to hydro generation. Genesis cites advice from the National Institute of Water and Atmospheric research warning of an overall reduction of inflows into the South island hydro lakes, and increased dry-year risk, in the coming two or three decades.

Nor would it be easy to price Huntly out of the market. Coal is significantly cheaper than natural gas, and Huntly's capital costs are sunk.

It can offer power into the market at prices which reflect its short-run marginal cost - the cost of fuel and other variable costs that are avoided if the power station does not run.

"As a result it cannot be competed out of the market by new plants needing to recover their long-run marginal cost - the average price they require to cover all costs, including fuel if any, and still deliver a commercial rate of return," it said.

The same factors make Huntly cheaper than other options for dealing with peak loads.

Genesis proposes an alternative strategy for the period to 2030 that would chart a middle course between the emissions growth to be expected under business as usual and the aggressive emissions reductions envisaged by the Government's draft energy strategy. It assumes electricity demand grows by 1.7 per cent a year - less than the historic rate of 2.1 per cent but more than draft strategy's 1.3 per cent.

It assumes a carbon price of $20 to $25 a tonne, but Huntly still runs until 2025. "It will gradually ease back Huntly to focus on its irreplaceable peak and dry-year firming role and will reduce emissions accordingly. It will achieve these gains without substantially raising electricity prices."

It sees growing market shares for wind power and geothermal energy, but also the need for another 1300MW of new gas-fired capacity, to (eventually) replace Huntly and older existing gas power stations.

The result is that in 2030 two-thirds of the electricity generated would be from renewable sources, about the same proportion as now.

The largest generator, Meridian Energy, which uses only renewables, wants the Government to start immediately on the staged introduction of emissions trading, leading eventually to a broad-based scheme covering all emitters by 2013.

It proposes starting next year with the thermal electricity generators, oil companies and suppliers of gas and coal to domestic markets.

The companies involved would initially have to surrender to the Government emission units to cover 20 per cent of the emissions from the fuel they sell or burn. The proportion would increase over time.

Units could be bought on the international market or from domestic sources such as the Permanent Forest Sinks Initiative or a revived Projects to Reduce Emissions programme.

In 2010 or 2011 the scheme would expand to include large industrial emitters, again increasing progressively over time.

By 2013 the remaining emitting sectors would be exposed to the price of carbon, including agriculture, with 40 per cent of the cap allocated free at first, reducing to zero by 2017.

Meridian said such a scheme sent very clear signals, prevented price shocks and transferred responsibility for the cost of emissions progressively to emitters, but did not eliminate the subsidy from taxpayers to emitters altogether until 2017.

As an all-renewables generator Meridian stands to profit handsomely if a carbon price is introduced into the electricity market. Wholesale power prices would rise, but its costs would not.

The Government has proposed introducing emissions trading to the electricity sector early, ahead of a broad-based scheme which it has signalled is its preferred option post-2012.

The Law and Economics Consulting Group has attempted to say what this would do to electricity prices.

It models three scenarios with four different carbon prices ranging from $11 to $30 a tonne of CO2.

The impact on electricity prices ranges from 0.4c/kWh to 1.2c, with an average of 0.67c.

That represents large transfers of wealth from consumers to generators or those selling them emissions units. Over the 2008 to 2012 period it would range from $450 million to $866 million depending on the scenario.

But it would buy little reduction in emissions - just over 1 million tonnes a year or about 4 per cent of the emissions saving required by New Zealand's Kyoto target.

Electric Shock

* Less than 10 per cent of New Zealand's greenhouse gases come from the electricity sector but the Government has indicated it is looking for early gains there in its quest for lower emissions.

* Emissions from electricity generation have risen steeply in recent years, partly because Genesis Energy's 1000MW plant at Huntly has switched from gas to coal.

* The Government's draft energy strategy envisages, as an "illustration", renewables replacing Huntly by 2015, leaving it as reserve for dry years. Genesis begs to differ.

* Its fellow SOE Meridian Energy urges the Government to get on with introducing emissions trading. It stands to pocket hefty windfall profits from such a policy.

* But economic consultants LECG calculate that would cost electricity consumers dearly for little reduction in emissions.