Brian Fallow: Power policy sends shivers through investors in generation

The thick end of $200 million a year ought to buy quite a lot of insurance.

The Government estimates the cost of ring-fencing reserve electricity generation capacity as insurance against the risk of a very dry year will be less than 0.5c a kilowatt hour.

It sounds insignificant but multiplied by the 38,000GWh consumed annually that is $190 million, not a trivial amount to divert from other uses.

Whether the regime outlined yesterday will deliver the security of supply sought - without perverse and counter-productive effects on investment in "ordinary" generation - depends on answers to key questions the new Electricity Commission will have to decide, after a consultation process. Not only is the devil in the detail; he is attended by a legion of lesser imps and demons.

One key unknown is how much generating capacity will need to be set aside as reserve. It will run into hundreds of megawatts, but how many is for the commission to decide.

It will depend on its estimate of how much of a shortfall there would be from the hydro lakes in a very dry year, but also how ordinary thermal generators would respond to normal spot market signals in those years - a very slippery thing to model.

Then there is the question of at what price, or hierarchy of prices, the reserve capacity will be cranked up and power released into the market.

If the price is too low it would compete with ordinary generation, which would deter investment by new generators. If it is too high, spot prices would be higher than they need be.

Should the commission offer power at a transparent, standing price, providing more certainty for investors in new generation, or keep its own counsel and so allow it more effectively to counter gaming behaviour by generators?

The policy is still to rely on market signals to inform generation investment decisions.

But the larger risk the Government is running with this approach is that it is setting up a system under which the quantity, price and timing of the release of this standby power would be set and reset by regulatory fiat.

If that is not to have a chilling effect on investment in generation potential, investors will need to be very sure the reserve capacity will be, as the policymakers intend, kept well clear of the ordinary workings of the market.

But that could mean our $190 million a year premium buys us an insurance policy with too high an excess.