Is There a Magic Bullet for Energy Pricing?

Posted 14 November 2018 by Chris Hargreaves

The following post was written by Bryan Leyland for KiwiBlog. Bryan is an engineer with over 60 years experience in the energy sector and regularly comments on various topics. He is a strong believer in a single payer market and Carl Hanson, former head of the Electricity Authority argues against this here.

At Total Utilities, we track the competitiveness of contestable costs and been doing so for nearly 20 years. While this data is representative of our customer base (which is made up of small and large commercial and industrial customers and does not include residential customers) we have not seen large “energy” price rises over time. In fact, over-the-counter retail pricing has been relatively flat since the end of 2012 and akin to pricing in 2006. Much of this has been due to increased retail competition in the market providing customers with more alternatives than the traditional “big 4” generator/retailers.

energy pricing diagram

Non-contestable costs, primarily those that relate to the transmission and distribution of energy around the national grid and local grid infrastructure on the other hand, have continued to rise. These monopoly-based costs vary considerably around the country, for example, a typical split nationally between contestable energy and non-contestable pass-through charges is around 60/40. In Top Energy in the far north, it can be the reverse of this. Conversely, Auckland and Wellington the cost split can be 70/30 and in Christchurch 50/50. Regional networks, in the North Island particularly, due to its geographic shape and population imbalance suffer from covering large areas with lower customer density compared to main centers. As such maintaining the network over what can be very rugged and mountainous terrain is expensive.

So where does this leave us, the fundamental issues of the system still remain.

  1. In a normal year, we have enough generation to meet current demand, however dry year future proofing remains an issue given current Government policy.
  2. Natural Gas which is seen overseas as an answer to coal-fired electricity generation will continue to increase in price in NZ as we exhaust current drilling permits and fields come offline.
  3. The Government is looking to try to accelerate the uptake of Electric Vehicles but not talking about the cost of the required upgrades to network infrastructure to support rapid charging. As most rapid charging will be done outside of main centers, this will put increased pressure on more remote areas of the Government-owned Transpower network and local network operators.
  4. The cost of building and consenting new large-scale generation infrastructure well exceeds current wholesale prices that generators can charge. Gas-fired thermal generation or Geothermal generation is far easier to build than a new hydro scheme or wind farm due to the size of its footprint and lower impact on the visual landscape.
  5. Distributed generation such as Solar remains unsuitable for many parts of the country due to a lack of sunshine hours. Businesses would only realise a payback on outlaid capital after 15-20 years in most areas. Batteries are still carbon intensive to manufacture and costly to buy.

layers of energy pricing

There is no magic bullet to ensure long-term security of supply at competitive pricing

Why have increased

The Electricity Price Review has revealed that residential electricity prices have increased by about 80% above inflation since 1990. Why did this happen? We were promised that privatisation and the electricity market would reduce power prices.

An objective examination of the whole electricity industry and the effect of the reforms leads to some interesting conclusions.

Cross subsidies

Before the reforms many power boards cross subsidised residential consumers by overcharging commercial and industrial consumers. The removal of these subsidies is a factor in the increased residential prices.

The market

The Wholesale Market Electricity Development Group made a mistake when they rejected the recommended market model and chose a market that pays all generators the price bid by the most expensive generator selected to run. This would have been a good choice if New Zealand relied entirely on fossil fuel generation. New fossil fuel power stations produce cheaper power than older ones so such a market encourages the construction of new and better stations.

In New Zealand, the cheapest generation comes from old, low cost, depreciated hydro stations. The choice of a fossil fuel market structure pays these stations the much higher price needed by the most expensive fossil fuel station. Hydro stations then rack up their asset values to camouflage the fact that they are making windfall profits

The recommended market model would have ensured that consumers would have continued to get low-cost electricity from the hydro stations that they had already paid for and built new stations that would give the lowest system costs in the long run.

The chosen market structure has led to wholesale prices increasing when they should have decreased to reflect the major reductions in operation and maintenance cost that followed on from privatisation.

Control of peak demand

Before the electricity reforms all electric water heaters in New Zealand were remotely controlled by the lines companies to reduce system peak demand by more than 10%. The reforms destroyed this world leading system. Most lines companies abandoned water heater control because the reforms did not allow them to fully recover of the costs of operating, maintaining and expanding the hot water control system.

As a result of abandoning hot water control, new power stations and a $960 million 400 kV line into Auckland were needed and millions more were spent on reinforcing transmission lines and distribution systems. All this to meet a peak demand that would not have existed with the recommended market.

Assets revalued

The reforms also allowed Transpower and lines companies to massively revalue their assets and use this increased value to justify charging consumers millions of dollars more for assets that consumers had largely paid for already. This is a major factor in the increased cost of electricity.

Traders and retailers

The electricity market also brought us traders and retailers who, it can be argued, serve no useful purpose whatsoever. The recommended market model did not need them.

In our market, traders often compete to get selected to generate. But when generation is in short supply competition is virtually non-existent and the price that they bid is “a trade-off between greed and guilt”. (On several occasions in the last few weeks wholesale prices have spiked to more than 10 times the normal price for no apparent reason.) As two retiring CEOs pointed out, the way to make money in the New Zealand market is to keep the system on the edge of a shortage. With the recommended market the system operator would have ensured that sufficient generating capacity was available and selected the generators that would give a reliable supply at the lowest cost.

Retailers increase consumer costs by spending millions of dollars trying to steal consumers from each other and pretending to compete in selling a commodity that is identical for everyone.

Conclusion

So what of the future? It does not look good. Transpower has warned that the risk of serious shortages and high prices in a dry year is rapidly increasing and no one has plans for new power stations that would mitigate this risk.

The government ignores dry year risk because it is hellbent on shutting Huntly down and limiting gas supplies and believes that exploiting wind and solar power will solve all the problems. Never mind that they are much more expensive, require backup when the wind doesn’t blow or the sun doesn’t shine and don’t make any useful contribution to meeting peak demand.

The best and cheapest way of mitigating the risk of blackouts in dry years is to ensure that Huntly continues to provide dry year reserve with two or three generating sets and 1 million tons of coal available.

The government should be taking steps to make sure that we have an economical and reliable supply into the future. If it wants to reduce CO2 – a gas that promotes plant growth and benefits our agricultural industries – it should contemplate the construction of a major and very expensive hydro pumped storage power station in the hills above Roxburgh that would solve the dry year problem. Only then can it ditch Huntly.

The New Zealand electricity market is a classic example of what happens when the politicians and the decision-makers do not understand power systems and how difficult it is to provide a reliable and economic supply. Choosing the wrong market model has cost the customer dearly.

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