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What s wrong with the Electricity Market? Greg Sise Energy Link September PDF

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What s wrong with the Electricity Market? Greg Sise Energy Link September 2006 Abstract Given the amount of negative publicity it attracts, a casual observer would be forgiven for thinking the electricity
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What s wrong with the Electricity Market? Greg Sise Energy Link September 2006 Abstract Given the amount of negative publicity it attracts, a casual observer would be forgiven for thinking the electricity market has totally failed. Established almost 10 years ago, the electricity market is plagued by doubts about its ability to deliver a secure, reliable electricity supply at reasonable cost. Today we look at key issues and look for a way ahead, with an emphasis on policy. By implication, we include the natural gas market. What s right with the electricity market? Supply crises 2001, 2003, 2006 Demand growing at an ever increasing rate Not enough new generation being built Auckland crisis 1998, lack of transmission capacity into Auckland & top of South Island Electricity prices climbing Anti-competitive behaviour Conflict between Electricity Commission, Transpower, Commerce Commission and government Top decile security of supply at lowest decile prices. What more do we want? History Government department Commercialisation, SOE model Separation of transmission from energy Separation of distribution from energy Deregulation & privatisation Industry self-governance Regulator Legislation Electricity Industry Reform Act 1998 requires split of energy and lines business recent relaxation for lines companies to own more generation Electricity Act 1992 general rules around supply Electricity Governance Regulations 2003 includes market rules Electricity Commission Commerce Act 1986 general competition issues Electricity and Gas Industries Act 2004 amendments to acts above Contents Dry year security of supply Demand growth The Grid Electricity prices The spot, hedge & retail markets The gas market Electricity company profits Demand elasticity Investment Regulation and governance Has the market provided dry year security of supply? Inflow Variation Monthly Wind Speed and Inflows Waitaki Inflows (Pukaki & Tekapo) NI Wind Farm (Min, Ave, Max) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Installed Capacity and Demand GWh Generation Capacity and Total Consumption e3p 385 MW Tararua Stage 3 90,000 80,000 70,000 Stratford 200 MW Ohau A 264 MW Huntly 1,000 MW 35% efficiency Clyde 432 MW TCC 354 MW 47% efficiency OTA B 390 MW 52% effiency 60,000 50,000 Te Apiti Wind Farm 90 MW Whirinaki Dry Year Reserve Station 155 MW 40,000 30,000 20,000 10,000 0 Total Demand Total Capacity Sources: Energy Data Files Installed capacity is the maximum that can be generated. Dry Year Capacity and Demand GWh 60,000 Dry Year Available Energy vs Total Consumption Thermals 85% Inflows 50,000 40,000 30,000 20,000 10,000 Total Consumption Dry Year (1992) Capacity Margins Capacity Margins Capacity Margin wrt Dry Year Gen Capacity Margin wrt Hydro Loss 55% 800% 50% 700% 45% 600% 40% 500% 35% 400% 30% 300% Did the Market Provide Security? Yes and No Initially there was a dash for gas Then gas became scarcer and plans for new generation were stalled, e.g. Contact s Otahuhu C Less efficient or costly plant uneconomic and shut down, sold off Stratford, Otahuhu A, Whirinaki,, one unit at New Plymouth So EC s role in security arose in 2004 Typical Spaghetti Chart SI Storage Waitaki, Clutha, Manapouri-Te Anau 4,000 3,500 3,000 2,500 GWh 2, , , /04/04 5/05/04 5/06/04 5/07/04 5/08/04 5/09/04 5/10/04 5/11/04 5/12/04 5/01/05 5/02/05 5/03/ South Island Hydro Management Meridian manages lakes Pukaki and Tekapo key to security of supply in dry years, especially in the South manage storage very conservatively impact of their storage management and pricing on the market is very significant Conservatism results in early warnings and high prices Offset this year by the EC s monitoring Dry Year Policy Calls for voluntary savings 1-in1 in-60 years Government built Whirinaki EC contracts for reserve capacity EC monitors security of supply, e.g. Minzone highly effective this year Dry year security is not explicit in the market but the financial implications ensure reservoirs are operated very conservatively (Meridian) Rank Spring Summer Autumn Winter Dry Years 1991/ / New Zealand Dry Year Inflows 1991/ / / /06 Average Spring Summer Autumn Winter The Squeeze Environmental issues limiting options for new generation (large hydro, coal firing) and transmission (towers) Conservative hydro management means early warning Expectation of secure and reliable supply is increasing limited ability to use other energy sources (coal fired computer?) One thing s certain... we need that power. Once upon a time it i was just the lights that went out. Now it s our world. Nagging perception of an impending power crisis Whereas the reality is the capacity margin is holding Is demand growing out of control? 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 - Demand Growth Demand Growth EDF March Year Ended Total Consumption y = 657.1x R 2 = y = x R 2 = % 10% 8% 6% 4% 2% 0% -2% -4% GWh Population and Demand Population Based Demand Projections 50,000 GWh per annum 45,000 40,000 35, Can the Grid deliver? Grid Transpower does not participate directly in the electricity market 2006 added a new circuit Christchurch to top of SI Major Grid Upgrades Upper South Island 220/110 transformer Kikiwa to supply West Coast 220 or 400 kv supply Waikato to Auckland HVDC link replace Pole 1 control equipment new cables, higher capacity Waitaki Valley to Christchurch Upgrade circuits south of the Waikato Grid Investment Test EC has the role of approving grid investments for meeting reliability standards, or economic investments EC and Transpower apply the grid investment test does the proposed investment test have a positive net benefit? is the proposed investment the best alternative? Some room for interpretation around how the alternatives are developed and who develops them Has the market provided cheaper electricity? Days gone by... Wholesale prices need to rise to be around 9 or 10 c/kwh in order to justify building new generation. John Fernyhough,, Chairman ECNZ, during the 1992 crisis, referring to wholesale spot prices A Volatile Spot Market Monthly Average Price at Haywards Haywards Monthly Final Price Haywards Rolling Average Final Price $236.79/MWh 150 $/MWh 100 $27.62/MWh (Rolling ave) 50 $13.56/MWh 0 Oct-96 Oct-97 Oct-98 Oct-99 Oct-00 Oct-01 Oct-02 Oct-03 Oct-04 Oct-05 Electricity - Market or Markets? Generators Sales Spot Market Spot Prices, Variable Volumes Purchases Retailers, Norske Skogg* Fixed Prices, Fixed Volumes Spot Prices, Variable Volumes Hedge Market Larger consumers, often some exposure to spot Retail Market Fixed Prices, Variable Volumes Commercial Industrial Residential Market Share in 2005 Installed Capacity Market Share Meridian Energy 27.3% 33.7% Mighty River 12.3% 14.7% Contact Energy 30.4% 28.0% Genesis Power 17.1% 17.0% Trustpower 5.3% 3.2% Other 7.5% 3.0% Spot, Hedge & Domestic Prices Spot, Hedge and Domestic Prices Haywards Average Monthly Final Price Quarterly Domestic Energy Charge (Incumbent) Smoothed Hedge Index 80 $/MWh Oct-96 Oct-97 Oct-98 Oct-99 Oct-00 Oct-01 Oct-02 Oct-03 Oct-04 Oct-05 Gas = Electricity $/GJ 7 6 CCGT Cost and Average Price New Gas Price CCGT LRMC Haywards Price $/MWh Retail Margin Retail Margins 120 Otahuhu Spot Retailer's Costs & Profit Super Profit Cheapest Retail Energy / / / / / / / /06 Supply Demand Not to Scale Electricity Markets Highly uncertain supply Spare thermal capacity Hedge Buyers Could be used to hedge uncertain supply, but at what cost? Potentially unsatisfied demand for hedges There is an expectation that hydro inflows will be used to generate, not spilled Firm hydro supply Comalco CFDs help limit suppliers exposure to this region Firm thermal supply Retail load FPVV Covered by vertical integration Are developments in the natural gas market going to give us cheaper electricity? Reserves PJ 6,000 Proven Reserves (based on P50) Implied Years Reserve (Log Scale) 1,000 5,000 McKee Kupe 4,000 Kapuni Pohokura 100 3,000 Maui Implied Years Reserve excluding Methanex & Huntly demand 2, , Larger fields tend to be found first New fields around Taranaki likely to be smaller Access to infrastructure is key none in the South Sedimentary Basins Natural Gas Policy So much new generation is fired by natural gas gas prices are a key driver of the spot price of electricity government recognises this linkage Gas Industry Company attempt to allow the industry to self regulate under the so-called co-regulatory model charged with developing arrangements for gas markets GIC Required to follow objectives in the Gas Act: gas delivered to existing and new customers in a safe, efficient and reliable manner provide essential infrastructure promote competition & downward pressure on prices signal full cost of production and transport of gas reliability sustainability and efficiency customer preferences & fairness All helps once the gas is available, but limited role in exploration Gas Exploration If there is currently a case for government intervention in an energy market, it is to encourage exploration and the development of new gas fields Policy initiatives: lower royalties on discoveries before 2010 income tax exemption for non-resident seismic ships and rigs government paid seismic program supporting block offers Crown Minerals promoting NZ Are generators making excessive profits? Electricity Company Profits When supply crises hit, profits increase Similar to oil companies Low demand elasticity means we just keep buying unless voluntary savings are called Difficulties for new entrants: high capital costs, long asset lives complex supply industry & market arrangements hydro generators with low marginal costs and high resistance to spilling = difficult to gain market share vertical integration Are consumers doing their bit? Electricity & Air Travel Electricity and air travel industries have many similarities infrastructure: highways for electrons, highways in the sky high investment costs, high barriers to entry complex & technological One key difference many air lines lose money, few electricity companies do: WHY? Price, P Supply and Demand Curves Demand Elasticity = Q P p q Supply -11 relatively elastic -11 relatively inelastic Canadian study (medians): International business travel Short-haul haul leisure travel Quantity, Q Electricity Demand Elasticity Price, P Demand 0.05% of load responds to prices in real-time Supply We just keep on using it! Quantity, Q What about investment? Investment The electricity market has performed extremely well where new investment is concerned Low rate of demand growth means being the next to build is the only way of getting market greater market share No incentive to over-build = avoid price collapse Spot market signals changes to the LRMC much better and faster than centralised utility Government initiated Whirinaki plant is an example of how centralised,, politically driven investment is not efficient it s built in the wrong place! Large Hydro Schemes Add 20% for contingency for Aqua = 5.5 to 6.0 c/kwh (at least) Source: Infratil Update September 2003 Fuel Generation Summary (Assumes 85% Loading for Thermals) Delivered Cost $/MWh Gas - CCGT Coal South Island Coal North Island Hydro 75+ Wind with 9 m/s wind speed 70-90 Regulation & Governance Electricity Commission Objectives Principal objectives: ensure electricity is produced and delivered to all classes of consumers c in an efficient, fair, reliable, and environmentally sustainable manner r and promote and facilitate the efficient use of electricity (MOU with EECA) Specific outcomes: energy and other resources used efficiently risks (including price risks) relating to security of supply properly perly and efficiently managed barriers to competition in electricity minimised for the long-term benefit of end- users incentives for investment in generation, transmission, lines, energy ergy efficiency, and demand-side management maintained or enhanced full costs of producing and transporting each additional unit of electricity are signaled delivered electricity costs and prices subject to sustained downward ward pressure electricity sector contributes to achieving the Government's climate change objectives Commerce Commission Thresholds pricing regime Information disclosure regime Competition watchdog currently looking at competition in the electricity market is there evidence of anticompetitive behaviour? MOU with Electricity Commission Solutions? Solutions: Dry Year Security of Supply Continue to diversity supply especially away from SI hydro Improve investments in standby capacity Better information around Meridian s management of their hydro lakes Do more to encourage gas exploration investigate building infrastructure in the South government partnership with industry for gas? Solutions: Participation and competition Allow lines companies to re-enter enter the energy market Further relax the EIRA allow lines companies to build generation anywhere remove the requirement for corporate separation allow lines companies to retail their generation Reduce barriers to new entry, e.g. market rules Continue to fine tune the RMA Sell Mighty River Power and Genesis Power further improve diversity & efficient investment sell Meridian Energy only if dry year security of supply is sufficiently covered, or retain as an SOE Incentives for Transpower to maximise Grid capacity Solutions: Demand-side Management Leverage off climate policy, environmental concerns Get the message right is Whirinaki there to heat towel rails or only for emergencies? Standards, standards, standards Education and promotion NEECS get one that works! Higher prices help a lot!
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