This month's wholesale power price spike has highlighted the challenges faced by the electricity sector.
Wholesale power prices went through the roof early this month, putting some energy-intensive businesses under pressure and prompting the question: Is the system broken?
Some believe it is, and there is a growing list of industry insiders who say it’s due for an overhaul.
As it stands, the system still ticks over but only because NZ Aluminium Smelter’s plant at Tiwai Point has cut back consumption, and methanol producer Methanex has supplied much-needed gas for generation.
A bout of wind and rain has helped.
Even so, supply remains heavily dependent on the weather, an ageing, fossil-fuelled plant at Huntly and in Taranaki, and demand-response deals such as that used for Tiwai.
How to handle the intermittency of the system – when the wind stops blowing and the hydro lakes empty out – remains a key question.
Energy Minister Simeon Brown this week said the Government would act “with urgency” to reverse the ban on offshore oil and gas exploration and would remove barriers to allow the construction of facilities to import liquefied natural gas (LNG) as a stopgap measure.
Industry participants have said the problem has been hiding in plain sight for some time now.
Last November, Genesis Energy chief executive Malcolm Johns – a former chief executive of Christchurch Airport – said the level of risk inherent in New Zealand’s electricity system would not be tolerated in the aviation world.
In February, national grid operator Transpower said New Zealand needed to up its investment in flexible power systems if it were to meet increased demand this winter.
Johns said in April that New Zealand’s gas production was falling faster than forecasts predicted, while demand had not.
This week, Vector chief executive Simon Mackenzie doubled down on his long-held view that the energy system is going through a significant transition with the need for more capacity, changing customer needs, and climate change.
The system relies heavily on hydro generation but also on gas and coal to provide power when the lake levels are low.
The latest price spike to over $800 a megawatt-hour (MWh) – before Methanex came to the party – largely reflected the gas shortage.
Prices are now back to more normal levels of around $100MWh.
“There is very clear evidence that there is a problem in the electricity market,” said a well-placed industry source, who did not want to be named.
He says that when the blueprint for the market was written in the 1990s, the intention was that long-run prices should trace the cost of building plants.
The logic was that the cheapest plants would be built first and they would gradually get more expensive.
“So one would expect that if you built too many plants, then prices would fall and would then become uneconomic.
“If you didn’t build plants, then prices would rise, and it would become economic to build.”
But since 2012 building cost has been declining – thanks mostly to falling costs of wind-farm plants – with the stark exception of the Covid years when prices skyrocketed.
Long-run prices in the market started to rise, but the cost of entry fell.
The inherent volatility of the system is largely overcome with the use of derivative energy products, which help generators and consumers smooth out the impact of the price peaks and troughs.
Hedge contracts currently trade at around $150MWh whereas the average cost of entry is less than $100MWh – strong evidence that power prices are significantly above the entry cost, the source said.
The system had been designed to get prices to trend to the cost of entry over the longer term.
“We don’t have dynamic efficiency. We have very high value migrating from consumers to gentailers.
“My view is that we are not seeing anything like enough investment in new generation,” he said.
The source said that while there has been some investment in new generation, there had also been retirement of old plant.
Contact Energy’s ageing gas-fired Taranaki Combined Cycle Plant (TCC) – which can pump out 377MW – is due to be pensioned off at the end of this year.
“They say, yes, they are investing, but if you look at the total energy that will be lost from retiring TCC, it’s actually about equal to the energy gained by the new investments. New investments do little more than replace retiring plant,” he said.
“When you are a generator, you have a significant portfolio of existing assets, you don’t want to build a new asset that’s going to lower the price of your existing assets.
“There is no point in investing if it’s going to drop the price of your existing portfolio.
“The only conclusion that I can come to is that the gentailers are restricting the amount of investment in order to hold prices up, to make new investments economic.”
The local scene is in stark contrast to Australia, where there is huge growth in renewables investment – much of it funded by foreign capital.
“We are not seeing 300-400MW type solar and wind farms built by foreign investors here because they don’t have the PPAs [power purchase agreements] from the gentailers that make the project sensible.”
PPAs play an important role in the development of new renewable electricity generation projects, particularly for a developer requiring a level of revenue certainty to secure debt financing.
“There are two reasons for that. One, the gentailers have got their own projects, so why would they take a PPA from someone else when they have got their own? Secondly, if they let that happen too much it would decrease prices on their existing plant.
“The root cause is that there is an investment thesis that says you can’t build a project unless you raise prices – therefore you have to restrict the amount of new build.”
The big generators are Mercury, Meridian and Genesis – all of which are 51% state-owned – and Contact Energy.
“If you are an NZX-listed company, how can you keep your share price up if you build something that lowers the price of your existing portfolio?
“At the moment we are skating on thin ice with dry-year hydrology, but we are getting over that thin ice because we have Huntly, and Huntly is running three units now pretty much flat out.
“A sudden failure of Huntly right now would be a disaster for the country,” he says.
“If it closes or shuts down, we won’t have anything to cover the dry years.”
If adopted, LNG would be expensive and would keep power prices high.
Tiwai Point consumes around 13% of the country’s power production.
Earlier this year, Meridian, Contact and Mercury signed deals that involve supplying power to Tiwai for up to 20 years.
“The reason the smelter contract got renewed was that it would have depressed prices too much to not renew it,” the source said.
“Meridian, Contact and Mercury all came to the party because they would all be hurt by a surplus of energy in the market,” he said.
“These guys could not have afforded the price depression.
“I think that you can draw the conclusion that the electricity industry is no longer serving the interests of New Zealand.
“It’s simply siphoning off value to its shareholders.
“Maybe there is a case for New Zealanders being the beneficiaries of the industry, and not shareholders,” he said.
He says the problem in the industry is that very few people can work out the root cause.
‘The Electricity Authority can’t, and I don’t think the minister [Simeon Brown] understands the root cause.
“And the root cause is not all that simple.”
The wholesale market – which matches supply and demand with prices set on the half-hour – can be extremely volatile.
Per megawatt-hour, prices have been known to hit just a few cents compared with this month’s peak of over $800.
The ASX futures market, which offers generators and industry a platform to hedge their positions, shows the outlook does not look as bleak as this month’s headlines suggest.
Greg Sise, managing director at Energy Link, a consultancy, said the problems immediately facing the industry mostly reflect the situation with gas.
Over the short term, the ASX futures curve shows futures prices dropping sharply – reflecting the sudden influx of gas from Methanex and better hydro conditions.
Next winter, though, looks tight because of expectations that gas will still be in short supply.
However, further out looks better, with futures prices falling away again.
Sise said that decline further down the track reflected the likely impact of new generation coming on stream and a degree of optimism that more gas can still be extracted from New Zealand’s existing gas reserves.
“Even though things are uncertain at the moment, it seems that the futures traders are not jumping to any conclusions about a lack of gas further out,” he said.
“And we will have more renewable energy coming on stream.”
Sise said the overall system was working, although it could do with improvement.
“We wouldn’t be in this situation – where hydro storage has fallen to as low as it has – if it were not for the fact that gas is suddenly in short supply.
“What we need is more investment in making sure that there is gas available while it is still needed to generate electricity and to do other things.”
Sise said the wholesale market works so well that “any little wrinkle” turns up almost immediately as a change in spot prices.
“And what spot prices are telling us is that yes, there is low hydro storage and very high gas prices,” he said.
Sise said LNG was technically feasible but more domestically produced gas would serve the system better.
“There are plenty of people wanting to build new generation so that’s going to make us less reliant on gas, so that’s got to be a good thing in terms of security of supply and prices,” he said.
Overall the system looked to be functioning well, but Sise said there was room for improvement in the “over-the-counter” market for hedge contracts that are typically used by large consumers and the smaller energy retailers.
“There are definitely issues there in terms of companies’ access to hedging at the prices they need in order to remain in business,” he said.
Meridian chief executive Neal Barclay balks at the suggestion that the sector is suffering from underinvestment.
“A lot of it is not fact-based.
“You get the assertion that gentailers are not investing in renewables and that’s just false.
“Collectively, we have invested about $10 billion in the last 14 years and yet demand has not grown by a fraction.”
On its own, Meridian has $3b earmarked for investment over the next six years.
“The investment has been going in and we are all preparing for the lift in demand that we expect to see as we start to decarbonise.”
He noted that big projects – such as Meridian’s $448m just-completed Harapaki wind farm – were built against the background of Tiwai’s owners threatening in 2020 to shut the plant by the end of this year.
He also strongly rejected the assertion that the power companies were profiteering.
By the industry’s preferred measure, Meridian’s earnings before interest, tax, depreciation, amortisation and financial instruments (ebitdaf) were up 16% at $905m, in line with market expectations. Meridian declared a final ordinary dividend of 14.85 cents per share, bringing the total to 21 cents – up from last year’s total of 17.90c.
Barclay said the company had to run on more conservative lines once Rio Tinto had first given notice that its Tiwai Point plant could close by the end of this year.
Now that Rio has committed to a further 20 years, Meridian’s latest result represented a return to more normal transmission, he said.
“The insinuation that we are price gouging is just fundamentally wrong,” he told the Herald.
Since its public listing in 2013, Meridan has had a “pretty modest” annual return on equity of 5%.
Barclay says that weather permitting, hydro lake levels should be back to normal by early next year.
Some commentators have noted that Tiwai, if it had closed, would have released 13% more power into the system.
But Barclay said “de-industrialising” to ensure there was enough power for everybody was “not sensible”.
He said the system was resilient but that the gas shortage caught everyone out.
“We have worked our way around that by securing some gas off Methanex, which is helping to fill up those lakes, but we need a better solution to that and we need it quickly.
“That’s why we are reasonably enthusiastic about this LNG opportunity.
“LNG will not be cheap, so it’s not a replacement for consumers who use gas for manufacturing purposes, and it’s not a replacement for baseload power generation, but it can be a viable solution to firm up hydro when we don’t have water in the lakes.
“It will also give us more visibility about what’s going on in the gas sector.”
When benchmarked against international sectors, New Zealand turns up in the top 10.
“It’s delivered cost-effective energy for most New Zealanders for more than a decade and a half, so it works.
“For me, the weakness that we have is just the relationship between the gas and the electricity sector – the lack of transparency in gas, and the implications that that lack of transparency has for managing the electricity system.
“That’s the bit that we can improve on.”
Barclay noted that the big gentailers have strong balance sheets and that all were pushing ahead with big renewable energy projects.
“You have got a whole bunch of new generation companies investing in New Zealand, so the barriers to entry are not there.
“I think the health of the sector is really strong.
“It’s just that we need this backup fuel issue resolved.
“For me, at the moment, it comes down to what’s going on in the gas sector.”
As New Zealand pursues its goal of net zero carbon emissions by 2050, how will the system evolve?
“At its broadest level, the more diversified renewable energy that we have spread throughout the country, the less significant droughts – particularly in the South Island – the less they become impactful,” Barclay says.
“We still think that we are going to need some gas – potentially coal – for the next 10 to 15 years, but beyond that, with the advent of customer demand response, we think that the system works.”
Daily intermittency – when power is needed to cover the peaks and troughs – can largely be solved through the use of large, grid-scale batteries, Barclay says.
“It will be a bit bumpy in the next 10 years for sure, but in the long run, a more renewable grid will become a more reliable grid.”
Jamie Gray is an Auckland-based journalist, covering the financial markets and the primary sector. He joined the Herald in 2011.
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