Electricity Prices

VIEWS FROM OUTSIDE THE APIARY: IAN FLETCHER

High electricity prices this winter seem to be doing some real economic damage. Manufacturing under pressure, job losses, and of course retail prices likely to rise too. Meanwhile, warmer weather over the past week has sent wholesale prices down from around $1000/Megawatt hour to an average price of 1 cent as I write (I started on a warm Sunday evening). What should we think?

I should declare my interests: I led the team responsible for electricity and gas policy in the UK from mid-2000 to mid-2002. I am also a director of a technology spin-out from Massey University, Captivate Ltd, looking to commercialise a carbon-capture technology.

The Clyde dam, the last big hydro scheme built by the government, completed in 1993. Hydro makes up the lion’s share of the renewable electricity generation in New Zealand, and renewables around 85% of total electricity generation.

Electricity generation in New Zealand is dominated by legacy hydro systems. The last big scheme – the Clyde dam – was completed in 1993. It means we face a long-standing dry-year risk of low lake reserves. This is quite predictable. It always occurs in winter, when demand is high and rain is replaced by snow in the alps (so we get the water later, when it melts). In recent years, we’ve added more geothermal power, some wind, quite a bit of gas and the last-resort diesel plant at Whirinaki. Something over 85 per cent of our power is renewable (hydro, geothermal, and wind, in that order). Coal still plays a significant role, all burnt at Huntly.

Electricity demand is the big variable. Demand is growing with population, the electrification of transport, and improved living standards (more air conditioning and heat pumps). Demand is growing most around the north of the North Island, where most population growth is taking place. We know now too that the Tiwai point smelter will keep running for the foreseeable future. If it had closed, it would have taken a lot of pressure off the system.

Not all electricity is created equally. The system needs steady ‘baseload’ power to keep it stable (managing the frequency, as well as keeping the vital high-voltage system ‘lit’). It also needs lots of on-demand power to ensure the ups and downs of wind and future solar generation can be evened out minute by minute, together with ups and downs in demand. Hydropower is really good at all of this, but the days of big new hydro projects are probably over – too expensive, too commercially risky, and too environmentally controversial. Its importance will gradually fade.

So, we need to meet a lot of growing future demand from different kinds of generation. And we do it with a privatised system. Of course (as we’ve seen over the past fortnight), the system is also subject to a lot of political pressure and commentary.

Hoping for investment through a privatised system exposes an awkward truth: low electricity prices tell investors they should go elsewhere – there is enough power now. Only the prospect of higher prices, sustained over time, provide the signals to private companies that they can profitably invest.

Keeping the lights on in Auckland is getting more difficult, with the growing population putting a heavy strain on New Zealand’s already stretched grid.

Higher prices will also suppress demand (good in theory; less so if it’s your job on the line). So, for consumers and workers today, low prices are good. But, for a better, sustainable generation mix, for less carbon emitted, and for a network big enough to meet future demand, high prices now are essential. In today’s system, we can’t say let’s have high prices tomorrow – that would essentially mean rigging the market to ensure future profits.

This is a serious conundrum. The politics of today undermine the economics and environmental policies of tomorrow. Today will always win. So, expect continued dry-year crises, continuing use of coal, and (this government at least) encouraging more gas-fired generation. And expect continued political grandstanding whenever prices rise unexpectedly, as they surely will.

At least that will all keep the lights on. This is so-called security of supply: having enough extra generation on hand to meet unexpected demand, or replace power lost through breakdowns, storms and so on. Generally, it means having to pay for more generation that we need in normal times.

Before privatisation, we did this by simply building dams ahead of demand, and investing in some North Island thermal generation (i.e. Huntley). After privatisation, this has been harder to achieve. The former reserve energy scheme has gone, and the Ministry of Business Innovation and Employment’s website bravely says that security is provided by ensuring that market participants have clear incentives to manage risks. This is foolish: we know companies can only manage risks they can reasonably foresee, and can price. And of course, if an event strikes much of the industry at once, then the market will be overwhelmed by physical failures. No number of incentives, or penalties, or legal obligations can make electricity if the system is physically broken. Whatever the law says, the laws of physics always win.

Cold dry winters will come and go. We cope with that. Windy politicians will come and go too. We cope with them. But if we are to keep the lights on, and meet some reasonable sustainability and zero-carbon goals, we will need to think again about prices, investment, security of supply, and the role of the government as regulator and as investor. The 1960s Ministry of Works beckons, at least a bit.

Ian Fletcher is a former head of New Zealand’s security agency, the GCSB, chief executive of the UK Patents Office, free trade negotiator with the European Commission and biosecurity expert for the Queensland government. These days he is a commercial flower grower in the Wairarapa and consultant to the apiculture industry with NZ Beekeeping Inc.