Energy prices set to outstrip inflation

By BRIAN FALLOW economics editor

Electricity prices are set to rise faster than general inflation over the next 20 years even under optimistic assumptions, according to modelling by the Ministry of Economic Development.

The ministry's Energy Outlook to 2025, released yesterday, projected an annual average real increase of 1.4 per cent in wholesale electricity prices for the period 2005 to 2025.

Wholesale prices make up about 40 per cent of a residential consumer's power bill.

That result is for the model's reference scenario - projections based on a set of assumptions the ministry considers "reasonably likely".

The assumptions include gross domestic product growth averaging 2.5 per cent a year (compared with the actual 3.4 per cent a year recorded over the past 10 years).

Electricity generation is projected to grow at 1.2 per cent a year (compared with actual growth of 1.6 per cent a year in the 1990s).

The lower rate of increase largely reflects the fruits of the National Energy Efficiency and Conservation Strategy, officials explained.

It assumes new natural gas supplies will be discovered at a rate in line with past discoveries excluding the giant Maui field, despite the present dearth of drilling activity.

And it assumes there will be a carbon tax of $15 a tonne, despite uncertainty about whether the Kyoto Protocol will come into force.

Even on those assumptions New Zealand would need 3355MW more generation capacity by 2025.

Nearly two-thirds of that would be from renewable sources - hydro, geothermal and wind, the ministry says.

Other scenarios require more generation, using up cheaper options earlier, and therefore implying prices rising faster.

For example, if economic growth were to average 4 per cent, wholesale electricity prices would by 2010 be about 10 per cent higher than in the reference case at 7.3c/kWh and 21 per cent higher by 2020.

If there are no new gas discoveries prices rise faster from 2010, the gap widening to 17 per cent by 2020.

Even a scenario with less energy efficiency but no carbon tax has prices rising faster than in the reference case.

This is because cheaper gas supplies are depleted more rapidly, less favourable wind power sites are required earlier and coal-fired generation is required, which at least in the North Island is one of the higher-cost options even without a carbon tax.

On the ministry's estimates of the cost of new generation, and assuming the cheapest options are exploited first, the next major increase in supply would be Meridian's 550MW Project Aqua, projected to cost 4.5c/kWh.

But that does not include the cost of upgrades to the national grid needed to get that power to market.

The next tranche is about 1000MW of geothermal and wind power resources estimated to be commercial at a wholesale price of 6.2c/ kWh.

Gas-fired combined cycle power stations of the kind planned by Contact and Genesis (about 800MW between them) are estimated to cost between 6.5 and 8.5c, including the carbon tax.