How we beat the power cuts

By CHRIS RUSSELL*

The New Zealand electricity market faced the biggest test of its five-year life this winter, as dry weather raised the prospect of power shortages, writes Chris Russell, chief executive officer of M-Co, the equivalent of the Stock Exchange for electricity.

Make no mistake, he says, the existence of NZEM is a key reason why the lights stayed on this winter. “Without the early warning system provided by the market, New Zealand could easily have experienced a repeat of the blackouts suffered during a similar hydro-electric power shortage in 1992.”

NZEM, or the wholesale market, was set up in 1993 in response to the 1992 power crisis. Run by the independent company, M-co, one of its main goals is to avoid future power shortages.

The others are to fix a “fair and efficient” price for electricity and to encourage smart investment in new power plant.

A quick look at what’s happened this winter shows NZEM is doing all three jobs remarkably well, Mr Russell says.

Before the 1992 crisis, electricity prices were set by former state-owned monopoly generator ECNZ, but were capped at 15c/kWh.

“As a result, no one really knew if the price ECNZ came up with was fair. The generator tried to instil some competition into the process by getting its own power stations to compete with each other.

“But it was a bit like dancing with your sister, not the real thing”.

Also, no one but ECNZ knew exactly what was going on at its hydro lakes, Mr Russell says. “In fact, although dry weather was threatening to cause water shortages as early as late 1991, the seriousness of the problem didn’t become public until ECNZ made a press statement in May 1992.

“By then it was too late for voluntary conservation measures and power companies had no choice but to impose power cuts. Compare that with what happens now.

“Today, electricity is traded in a competitive spot market where, in close to real time, prices are set for each half-hour of every day. Bids and offers made by generators and power users are ranked from lowest to highest, and where they meet a price is struck.”

The price-setting process is transparent and ensures the cheapest power is always sold first, he says.

“In fact, NZEM has played a big part in New Zealanders enjoying some of the lowest power bills in the world during the last five years, even taking into account this winter’s price spikes”.

Now let’s look at how NZEM has helped New Zealand avoid a full-blown power crisis this winter.

The fact the dry summer was having an impact on hydro lake levels has been public knowledge since the start of this year, when prices in the wholesale market began rising higher than usual. “Compare that early warning with 1992 when the first public knew there was a problem was in May.

“The market has continued to act as a gauge of how serious the threat of power shortages is. Daily average prices briefly hit 40c/kWh in late July as concerns grew, then dropped to 10.6c/kWh in mid-August as voluntary conservation efforts helped cut demand. The lower the national storage level the higher the price”.

Mr Russell says the spike in prices — which have been four or five times higher than normal for much of this winter — has not been pleasant for those buying power on the spot market, including electricity retailers and many businesses.

“But it’s been extremely important in avoiding power cuts, by motivating Kiwis to voluntarily cut their usage. Without the market, businesses probably would have suffered more because they would almost certainly have faced power cuts, which gave them no control over where and when they cut production.

“Forced power cuts would also have had a greater impact on economic growth than voluntary conservation measures.

The market’s impact on the shape of New Zealand’s electricity industry has also been crucial in avoiding a full-blown power crisis this winter”.

NZEM, he says, is one of the few markets in the world to have locational pricing. The supply-meets-demand calculation is done at nearly 250 points around the country, creating a long-term picture of where prices and demand are going in each region.

Making sure new plant is built where it is needed is important for consumers because transport costs are a big component of their bills. “The further you ship electricity the more expensive it becomes because the laws of physics mean some power is lost along each kilometre of the journey.

“The regional data provided by NZEM helps arm generators with the economic evidence needed to justify investment in new plant, as well as telling them where to build it. This is a key reason why most of the generation capacity added since 1996 has been located in the North Island, particularly near the growing city of Auckland.

“Not only has this made the system more efficient, it has enabled supply to meet the increase in demand for electricity, which has risen more than 20 per cent since 1992’.

The increase in capacity, Mr Russell says, has also reduced New Zealand’s reliance on hydro generation — a crucial factor in the lights staying on this winter. Most of the new North Island generation has been gas-powered, as environmental factors and geography mean hydro is not an easy option.

As a result, about 40 per cent of the country’s electricity is now generated from sources other than hydro, compared with only a quarter in 1996.

“This change has enormously reduced our exposure to climatic events and NZEM is one of the main reasons it has happened.

The winter price hikes have prompted calls for price caps from some quarters. But experience shows price caps harm power users more than they protect them. Price caps in force in 1992 hampered ECNZ’s ability to persuade consumers to cut back on usage and partly led to the blackouts”.

Mr Russell says California struck a similar problem this year when price caps contributed to rolling black-outs because that was the only way the state’s power companies could get consumers to switch off.

“At the end of the day, price caps would simply distort the message being sent by the market — that we have a potential power supply problem and we need to conserve. There’s also been criticism that high wholesale prices are damaging competition, forcing at least one electricity retailer, On energy, to quit the business.

“On energy was left exposed to high wholesale prices because earlier this year it did not take hedge cover to insure against price hikes. Whether it chose not to take hedges or just couldn’t find a generator to sell them, isn’t known. Certainly shortages of hedge cover are a problem in electricity industries around the world, largely because generators don’t want to over-commit themselves”.

But the problem lies with the make-up of the wider electricity industry, not the spot market, Mr Russell says.

“In New Zealand it is made worse by the fact generators are also allowed to retail electricity. As a result, they want to fulfil their own customers’ needs first, reducing the amount of hedge cover they’ll offer rival retailers.

“Some commentators have suggested New Zealand doesn’t have a potential power crisis, that generators are merely using the fear of shortages to drive up prices and boost their profits.

There has also been claims that lake levels aren’t low enough to justify the prices we’ve seen this winter.

“Again NZEM has played a key role in making clear exactly what’s going on”.

Hydrological information published by the market shows that lake levels, at their lowest this year, were 54 per cent of normal, compared with 18 per cent in 1992. However, Mr Russell says, 54 per cent is still a major concern, “especially when you take into consideration the low level of water flowing into the lakes, which is only 86 per cent of average so far this year. The other worry is next year — what happens if we start off with low lake levels and we have another dry year in 2002’?

So, it is a combination of low inflows, low storage and increased demand for electricity that has driven prices so high over the last few months. The winter’s price spike has also prompted some to call for more regulation of the wholesale market.

But regulation has its own price, Mr Russell says. It costs about £150 million ($474m) a year to run Britain’s wholesale electricity market, of which about 90 million pounds is clocked up by the gas and electricity regulator.

“Our market, which is largely self-regulated, costs about $20 million a year to run, including spending by Transpower on operating the national grid. Sure the UK’s market is larger, but not so much larger that it justifies the difference.

“At the end of the day no amount of regulation is going to make it rain. And, short of us all unplugging our televisions and heaters, only rain, snow melt and more rain will bring wholesale electricity prices back to normal.

“Until then, NZEM will continue to do what it was set up to do — set electricity prices that warn us we have a potential power supply problem and that we need to conserve a scarce resource”.

* Chris Russell is the chief executive officer of M-Co.

Power to the People Supplement