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Trends in the New Zealand Electricity Market

Christopher Russell Chief Executive

Overview



Update on trends and developments in the New Zealand electricity market

» The demise of a self regulatory regime, and » The move towards heavy handed regulation 

A cunning plan

» Reserve generation » Long term impact on the market

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Topic 1 – Update on Trends

Current Governance structure

 Three voluntary governance arrangements » NZEM – wholesale spot market – operational since 1996 » MARIA – covers metering, reconciliation and bilateral trades – established in 1994 » MACQS – to cover security and quality of electricity transported across the grid – established in 1999 but not operational  Eight Service Providers  Market based on LMP  Annual traded volume through NZEM – 28,862 257 mWh  Amount paid by purchasers – NZD 1,439,229,956

Single Governance

 Labour Government commenced a review of the industry in 2000  Review recommended a single Governance structure  Industry Commenced a project in December 2000 “EGEP” to establish a self Governance structure » Mandatory Pool » Consumer voting rights » Operationalise MACQS  EGB rules went to vote on April 2003 and failed to obtain a majority  Government exercised its powers under the Electricity Amendment Act 2001 to establish the Electricity Commission

The Electricity Commission

 It is a Crown Entity, with six independent Commissioners  The original plan called for the EC market to “go-live” by 1 October 2003, that is now planned for 1 February 2004  The commencement market rules are largely based on the EGB rules but the Commission has additional responsibilities, above and beyond running a market as set out in a GPS » require generators to offer long-term hedges » responsible for ensuring modelling and forecasting of future supply and demand » require additional information disclosure » address transmission investment  Now lines Companies will be able to own unlimited reserve generation

Other issues

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Adoption of the EGB rule book means that the EC market will be a Gross pool - problematic

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The EC is required to ensure security of supply in dry year (one in sixty)

How did we get to this point - lessons

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Lack of ongoing reform

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Vertical integration stifled the development of a hedge market and retail competition

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New Zealand’s exposure to dry year risk (hydro with only 16 weeks storage)

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Government a major player in the industry

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The “political” cap price

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Topic 2 – Solution = Reserve Capacity

Government Approach to RG

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The Government’s view appears to be:

» Markets under-provide security of supply » Financial interventions are inadequate to assure security of supply » A ‘bricks and mortar’ approach provides the best assurance of security of supply 

The Government’s policy is to require the EC to

» Operate to a ‘1 in 60’ dry year security standard » Achieve this by contracting for reserve generation capacity and fuel » Withhold reserve generation from the market until dry year conditions are likely » Fund financial deficits of RG with a levy

Forecasting Quantity of RG

Forecasting Energy Gaps

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Energy modeling and forecasting will now play a critical role in dealing with dry year situations

» But strong incentives for forecasters to over-estimate RG requirements » Impose high levy costs on consumers – perhaps involve consumers in setting RG quantities » Critical for the EC to set up modeling and forecasting arrangements appropriate for meeting its new responsibilities

Forecasting Quantity of RG Intervention Conditions for RG

What price level for intervention?



Efficient to set intervention price at LRMC

» Could price at SRMC if RG deficits funded with hedge contracts 

However the Government has determined to set the price at $200 per MWh

» Serious risk of crowding out ordinary investment in mid load and peak-load capacity, and stifling the hedge market » Sets a price cap » Imposes administration and compliance costs on consumers

Committing to the Intervention Price

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EC may face strong pressure to ratchet-down intervention prices

» Difficult to resist intervention when RG sitting idle and consumers are hurting badly from high spot prices » Generators may be viewed as gaming the system 

Credibly committing to intervention prices or intervention formulae is critical for minimising displacement of ordinary generation and distorting the market

Forecasting Quantity of RG Intervention Conditions for RG Contracting RG

Method of Contracting for RG

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Intention is for RG contracts to pay separate prices for capital costs, O&M costs, and fuel costs

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Hence, selecting RG suppliers requires trading-off capital costs against variable costs

» May not always be obvious who should win the contract » May create opportunities for bidders to undertake significant influence activity » Real risk that least-cost projects will not be chosen

Contracting Requirements

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Tender and contracting processes

» Need competitive and transparent tender processes » Need sophisticated and transparent cost-benefit modeling to compare proposals » Need detailed guidelines and audit trail for contract negotiations 

Allow demand side participation in RG tenders

» Embedded generation » Sellback of forward contracts

Forecasting Quantity of RG Intervention Conditions for RG Funding RG Contracting RG

Funding RG with A Levy

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The intention is to partially fund RG with a levy. If impose a levy then

» Levy should be on energy consumed » Should collect levy from retailers and wholesale consumers 

Funding RG with a levy would seriously diminish hedge market activity and incentives for self innovative provision of firm capacity

» Need to exempt consumption supplied from (1) self-generation and (2) firm capacity contracts » Failure to provide exemptions leaves these consumers paying twice for their electricity