Dynamic Business: Investors eye NZ’s energy transition amid funding challenges

Turitea South wind farm near Palmerston North owened and operated by Mercury Energy Spetember 2021...picture supplied......FREE FOR EDITORIAL USE...NZH 07Dec23 -

New Zealand already has a very high proportion of renewable energy on the nation’s electricity grid. However, it still needs to prepare for and fund its energy transition.

Russell McVeagh, partner and head of infrastructure Michael Loan says that while last year 88% of our generation came from renewable sources, there is going to be a much greater demand for electricity. “It’s going to be driven by the electrification of industry and transport. There will be new large loads on the system from data centres and other sources.

“If we are going to meet that demand we will need significant new generation capacity. Having a market that can provide the extra generation will be critical.”

Because New Zealand started from an advanced position compared with other nations, there is a wealth of overseas expertise to draw on about how to fund our energy transition.

Loan says renewable energy generation comes with its own set of challenges: “Using solar and wind means having more intermittent generation that requires a system-wide approach. Core industry players, such as the Electricity Authority, are focused on ensuring the system remains reliable and secure as demand grows and reliance on intermittent generation increases.”

Loan says New Zealand’s energy system is unique. “We have significant amounts of hydropower on the grid. However, the winter price spikes we saw earlier this year in the wholesale electricity market highlight the challenges we face when hydro storage is low.

Russell McVeagh partner and head of infrastructure Michael Loan

“It means we need more capacity on the system to better manage the fluctuations in supply and demand. As a country, we need to do a better job of accessing the deep pools of capital that international institutional investors are deploying in this space to accelerate the build of that capacity.”

One possibility is to operate grid-sized batteries like South Australia’s Hornsdale Power Reserve, which is designed to support the flow of intermittent renewable energy into the state’s grid.

Loan says there are investors looking at battery energy storage systems and that will become increasingly important. “Where you have intermittent generation, there is a need to shift that generation from its time of production to when it’s actually needed, which is where batteries come in.”

There is some local capacity for investment in energy transition. Loan says the gentailers (generator-retailers) are pressing ahead with their own investment pipelines. In many cases, they are looking to fund investment on the balance sheet.

“For the independent developers and the energy sector more broadly, there are huge benefits if they can attract the world’s pension funds and infrastructure fund investors to New Zealand.

“Accessing that capital would release the potential to really move the dial. The trick lies in having the projects that can attract that kind of capital.”

New Zealand has a long pipeline of potential energy transition projects. Much of the discussion around barriers to these projects centres on the consenting process, which needs to be streamlined.

However, Loan says that is not the biggest hurdle: “The hard part is being able to bring forward a project with a sound investment case and a de-risked revenue stream to attract those infrastructure investors that are looking for low-risk returns.”

This is where it gets difficult. In other infrastructure sectors, public-private partnerships generally provide availability-based revenue streams. This means investor returns don’t depend on energy demand or how much the asset gets used.

“The real risk is what is the price of the output that you are producing? In many countries, the price is supported by government-backed instruments like contracts for difference.”

In the energy sector, this is an agreement that says the counterparty must pay the project the amount by which wholesale prices fall below the agreed strike price for the contract volume, and vice versa.

Loan says these government-backed contracts are common in countries looking to transition away from significant fossil-fuel-based systems. They are critical to providing investors with the certainty they seek.

“We don’t have these in New Zealand. Here the pervading market view is that the role of government is to provide an enabling, consenting environment, but to otherwise leave it to the market to deliver projects.”

He says in practice there aren’t many investors willing to put their money into projects on a purely merchant basis. That would be investing on the basis that all the output is sold on the market at spot pricing.

This means having a view of the price path is important. However, New Zealand’s wholesale electricity market is complicated.

“There are not many investors who are willing to take that risk. This is why, for independent developers, getting a power purchase agreement that provides long-term fixed pricing for the project is critical to raising the necessary capital.

“The capital will be there for the right project, but it really depends on the business case and the particulars.”

It’s common to see companies with projects needing considerable energy such as data centres signing fixed-price contracts before a wind or solar farm is built to provide the power.

Loan says there can be huge benefits for corporate or industrial energy users to sign up for these agreements and access the pricing available from a generation project.

And such agreements are often critical for underpinning the project’s investment case.

“The challenge for that type of user is they want power that matches their load. So, they also often want what’s called a firming product to ensure that they’re getting electricity that matches that what they need”.

It’s not only about having pricing certainty, investors also look for certainty in other areas. Loan says they want: “…certainty across the entire suite of project rights and expected capex requirements that will support the investors’ risk appetite”.

He says project financing can be complex and getting a project from an idea through to the start of construction can require significant work.

“You also need an investment environment that will facilitate and support that flow of capital. Overseas investment regulations are important.

“Our Overseas Investment Act is one of the most stringent internationally. Any project that involves using sensitive land must prove it delivers net benefits to New Zealand. Any further investment in that same project is technically required to demonstrate additional benefits.

“It’s very welcome that the Overseas Investment regime is under review and will be reformed. We’ll be watching that closely,” says Loan.

Russell McVeagh is an advertising sponsor of the Herald’s Dynamic Business Report.