Questions and Answers: Electricity supply security

Supplied by the Energy Minister, the Hon Pete Hodgson:

What's the problem?

The current electricity market does not appear to provide enough incentive for generators to provide for adequate supply security in very dry years. Reserve generation for use in very dry years will not be used often enough to make an adequate return on capital by normal commercial criteria. As a result old thermal plant is scrapped rather than retained as reserve generation. Pressure on the system in very dry years raises concern about electricity shortages, producing very high and volatile spot market prices.

How much dry year generation do we have already?

Major thermal power stations total more than 2000 megawatts in capacity, some of which is used effectively as dry year reserve. Management of dry year risk is left to the market, rather than any single authority, and there is not a designated 'portfolio' of reserve generation plant.

How will the Electricity Commission decide how much reserve generation New Zealand needs?

The Commission will use improved modelling of future electricity supply and demand to assess how much reserve generation is required to ensure that supply remains secure even in a 1-in-60 dry year.

What kind of plant will be used for reserve generation?

The reserve generation contracted by the Electricity Commission is expected to be a mixture of existing and new plant. It is also possible that portions of the capacity of individual power stations will be contracted as reserve. The balance between new and existing plant in the reserve generation portfolio will be determined by the Commission's decisions and negotiations with the industry. Reserve generation will be predominantly or entirely thermal and the Commission will contract for plant with a range of fuels, to manage the risk of disruption to any one fuel source.

What will reserve capacity cost and how will it be paid for?

The cost of securing the necessary reserve capacity will depend on decisions the Electricity Commission makes about the range of plant required, but is estimated to be well under half a cent per unit on the average price of electricity over the long run. This cost will be recovered by the Commission in the manner it judges to be most efficient, for example through a levy on the industry. The cost will ultimately be passed on to electricity consumers. The cost is expected to be low because the reserve capacity is expected to comprise relatively low capital cost plant, plus heavily depreciated old plant, and the fuel, though costly, will be rarely used.

Why is it unlikely that renewables will be used for reserve generation?

Generation from renewable resources uses free or cheap fuel (water, wind, geothermal heat, wood waste) and is more environmentally sustainable than thermal fuel generation. Renewable generation should generally be used as much as possible to meet baseload electricity demand, rather than being withheld for dry years.

Will demand management be counted as reserve capacity?

No. There will continue to be a demand side response to dry year spot price fluctuations, which will be factored into the Commission's modelling of supply and demand trends. But demand cuts in response to spot price increases will not be counted as reserve capacity. Nor will spinning reserve, which is already maintained in the system as a contingency against sudden outages.

Will the Commission own reserve generation?

No. The Electricity Commission will tender and contract for reserve capacity with any generator willing and able to provide it. The capacity will remain the property of the generator. The tender process will be open to all potential providers, so generators are not expected to be able to earn profits in excess of their cost of capital.

Who will decide when reserve capacity is used?

The Electricity Commission will set offer prices and conditions for reserve capacity that will trigger its use.

Why must reserve capacity be offered into the wholesale market at a high price?

If the price on reserve capacity was too low it would compete with ordinary generation, which would deter new investment by generators. A high price on reserve capacity will also ensure that the wholesale market will continue to have enough price variability to deliver the price signals and opportunities – including the signals for demand-side management – that it is designed to deliver.

How will this policy reduce the scale and volatility of spot prices in dry years?

Setting the price at which reserve capacity is offered into the wholesale market will significantly reduce spot market volatility in dry years. Prices above that of the reserve generation will be rare – although not impossible – so the range of variability will be much narrower than it is today. Very high spot prices could still occur if extreme circumstances, such as an exceptionally dry year or a major transmission or generation failure, exhausted the available reserve capacity.


Why is this policy focused on reserve capacity, when the problem in 2003 is not capacity but fuel?

The Government is not confident that current market arrangements can be relied on to deliver sufficient reserve capacity for the future. This policy will require the Electricity Commission to ensure that both capacity and fuel reserves are adequate.

Does this policy mean New Zealand's electricity supply will increasingly be based on fossil fuels rather than renewables?

Definitely not. While fossil fuel generation is likely to dominate reserve capacity, this will be a small proportion of total capacity and it is likely to be used relatively rarely. Renewables are expected to dominate growth in ordinary generation over the next twenty years, because available renewable resources are expected to be highly competitive and climate change policy supports their development. A report for the Ministry of Economic Development has identified 1,900 megawatts of additional renewables available at below 7 cents a kilowatt-hour, comprising 900 megawatts of hydro, 500 megawatts of wind and 500 megawatts of geothermal. Some other renewables, such as forestry biomass, will also come on stream over the next two decades.

Is it possible that some reserve capacity will never be used?

Reserve capacity will run only in very dry years, or during other extreme events, which might not occur for some time. This policy is based on the judgement that the expense of maintaining reserve capacity is justified by the desirability of avoiding the production losses, damage to New Zealand's reputation and public inconvenience arising from extended periods of high spot prices and repeated calls for electricity savings.

- Compiled by Office of the Minister of Energy