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Trends in the New Zealand Electricity Market

Christopher Russell

Chief Executive

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

Overview

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Topic 1 – Update on Trends

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

Current Governance structure

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

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

The Electricity Commission

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

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

Other issues

Lack of ongoing reform

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

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

Government a major player in the industry

The “political” cap price

How did we get to this point - lessons

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Topic 2 – Solution = Reserve Capacity

Government Approach to RG

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

ForecastingQuantity

of RG

Forecasting Energy Gaps

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

ForecastingQuantity

of RG

InterventionConditions 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

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

ForecastingQuantity

of RG

InterventionConditions for

RG

ContractingRG

Method of Contracting for RG

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

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

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

ForecastingQuantity

of RG

InterventionConditions for

RG

Funding RG Contracting

RG

Funding RG with A Levy

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