Not enough turbines: it's that simple

By BRIAN LEYLAND*

Most New Zealanders now accept that the electricity restructuring and the electricity markets have failed to give us what we need - an economical and reliable supply of power. Instead, we have insufficient generating capacity, not enough fuel and a dysfunctional transmission system.

We face a high risk of serious shortages this year and even higher risks over the next two to three years until new generating capacity comes on line. At best, this new capacity will only bring us back to the situation we are at now.

The high prices are a direct result of the market's failure to provide us with adequate generation and to co-ordinate the management of our thermal fuel reserves and hydro storage.

Since 1996 generating capacity has increased from 7800MW to 8400MW, an increase of 8 per cent (116MW a year) and less than the load growth. Those unfortunate enough to be on a spot-price contract now have to buy electricity at many times its cost of generation. Yet the extra cost of the reserve capacity we need, spread over all consumers, would be about 0.2c a kilowatt hour.

Despite this, some industry commentators still maintain that the market is working. In a sense they are right. What the market has delivered is exactly what some of us predicted - unstable prices and shortages in a dry year.

All this is a direct result of a market structure that does not reward those who hold reserve capacity. This led to Contact's decision to sell 350MW of reserve power plant to Australia in 2000, a rational response to the signals the market gave it. The market is now signalling that we need it back.

A few days ago the chief executive of the electricity marketing company M-Co said the high price signals indicated we needed new generation by 2005. What would he have said six months ago when the prices were only 2c?

The plain fact is that this market does not give the long-term price signals needed to match the five- to 10-year period between conception and commissioning of a power station.

The restructuring has also given us a dysfunctional transmission system. Transpower will uprate its system to remove constraints only if somebody else pays. Predictably, nobody has, and the constraints have cost the country many times what it would have cost to fix them.

What this country needs is a new market that operates in the national benefit. This market must manage the system efficiently during the tight situation over the next few years, and co-ordinate the expansion of the generation and transmission system to give the lowest overall cost of power in future.

This can be done only with long-term planning and co-ordinated operation of the system. Our power system was designed to optimise the use of low-cost South Island hydro power backed up by thermal generation during dry years.

If we want to minimise the overall cost of generation and manage droughts without seriously damaging our economy, we must build new stations as part of a long-term power plan.

The usual argument against this proposal is that we are simply returning to the past. But what was wrong with the old system was that power planning was subject to political manipulation. Power stations were built that were not needed, or were built in the wrong place.

To avoid this we must ensure the new power planning process is public, is subject to independent review and is free of political manipulation. The independent status of the Reserve Bank could be a model for the power planning group.

The construction and operation of power stations is the only truly competitive part of the electricity business, so to get the maximum national benefit we must make this sector competitive.

In the old days the Electricity Department and the Ministry of Works had a monopoly on the siting, construction and operation of stations.

A system co-ordinator, who is also a central buyer and seller of electricity, can bring competition to generation. Each existing power station would enter into a long-term contract with the system co-ordinator based on the cost of generation plus a fair return on investment and the promise of rewards if it were able to exceed guarantees on efficiency and reliability.

When new transmission or generation capacity is needed, the system co-ordinator will issue a "statement of opportunities" describing the new capacity wanted. The most attractive proposals for providing new capacity (including demand-side response) would be awarded long-term contracts covering capital and operating costs.

Such a system would guarantee that power was supplied at the lowest possible cost consistent with reliability.

This system also has other advantages. Investors in generating companies and their bankers would be sure of long-term stability. Consumers would retain the benefits of our low-cost hydro power because the cost of all the power would no longer be based on the cost of the most expensive generator or, as at present, on prices which are totally unrelated to costs.

Another benefit would be that any Kyoto taxes imposed on the gas- and coal-fired generators would not add to the price of power from hydro and geothermal power stations.

This new market would give us the economic and reliable supply that we need in the long term, and manage the tight situation we face for the next three or four years. None of the proposals I have seen has convinced me this could be done by tinkering with the existing market.

And the downside? If the system co-ordinator is seriously incompetent, we might be as badly off as we are now.

* Bryan Leyland is an energy consultant in Auckland.