• Home
• Energy & Resources
• New Zealand Energy Strategy
• Publications
• Draft Strategy Document
• 3. Security of ...

• New Zealand Energy Strategy

• Publications

• NZ Energy Strategy
• First Progress Report
• Monitoring Report
• NZEECS Annual Report 2008/09
• Appendix: NZEECS Annual Report
• NZES Development Publications

3.1 Our Direction

Approximately half of the energy we use outside the transport sector comes from electricity. The other half comes from the direct use of coal, gas and renewables such as wood, biogas, geothermal and solar. For non-transport energy, security of supply generally refers to a secure supply of electricity as a primary energy source and a reliable supply of input fuels for electricity generation.

Maintaining security of supply at competitive prices is essential for a modern economy.

Reliability is measured by the frequency and duration of supply interruptions. The cost of any specific interruption to a consumer depends on the time and duration of the interruption, and how much warning precedes it.

In light of growing demand, security (or reliability) of supply requires:

• building enough generation capacity to meet peak demands (usually on cold winter evenings, although summer peaks are increasing)
• ensuring there is enough fuel (including water and wind) to generate sufficient electricity at any instant in time and over time
• building enough power lines to transport power from generation plants to consumers, particularly at times of peak demand
• ensuring that cost-effective energy efficiency opportunities are realised.

All components of the power system, such as generation and lines, are inherently prone to infrequent and typically short-lived incidents that can interrupt supply to consumers. Incidents include equipment failure, the weather (such as high winds and lightning) and operational error. In consequence, there must be sufficient equipment redundancy and management systems in operation to minimise the likelihood of supply interruption.

3.1.1 Factors Affecting Choices about Security

Looking forward, choices about the security of electricity supply in New Zealand are strongly dependent on legacy features of the power system (the stock of generation and network assets built to date) and other characteristics: our isolation, which means we can't import electricity from other countries; our geography; and the quantity, cost and location of our local energy resources.

Figure 3.1: New Zealand's Electricity Supply

A particularly important feature of New Zealand's electricity system is our existing stock of hydro generation, which typically produces 60% of total electricity supply annually. There is variability in annual hydro generation, which stems from variability in rainfall in the catchments feeding the hydro lakes (see Figure 3.1).

Traditionally, supply security has been managed in the context of this hydro variability by building thermal generation stations using fossil fuels such as coal, oil and natural gas. However, there has never been enough thermal generation capacity to completely remove the risk of interruptions caused by hydro shortage. Instead, the power system has been managed so that the risk of power interruptions caused by hydro shortage is kept to a low level, with the ability to reduce demand through an emergency electricity conservation campaign providing the ultimate backstop. In this way, New Zealand has traditionally enjoyed relatively cheap (and low carbon) electricity generation, but with the associated challenge of having to manage some dry-year risk. There is a trade-off between having higher levels of security and cost.

3.1.2 Supply Security in a Market Context

New Zealand adopted liberalised market arrangements during the 1990s, breaking up the state-owned Electricity Corporation of New Zealand (ECNZ) to create a competitive market structure in power generation.

One consequence of the current market arrangements is that there is no longer a central plan for investment in generation. Investment decisions are made by individual firms in response to commercial drivers. This has the potential to create a perception that the electricity system is insecure.

In dry years, various market participants are affected by a shortage of fuels and higher spot market prices. Exposure to price risks tends to cause complaints and exaggerated predictions about the impact of price rises. This can affect public confidence in current market arrangements.

The experience, however, is that investment in new generation is occurring. In the near to medium term, there is sufficient generation planned to ensure adequate generation capacity.

Source: Ministry of Economic Development

3.1.3 Generation, Transmission and the Resource Management Act

All generation projects have environmental impacts and are subject to RMA approval. The economics of potential new investments are affected by consenting procedures and any conditions that are imposed. For renewable energy generation, unlike fossil-fuel-based generation, consent conditions determine the terms of the fuel supply contract.

3.1.4 Regulation of Supply Security

The electricity market is now overseen by the Electricity Commission (EC), a regulator established in 2003 to ensure, among other things, that the power system is adequately reliable. It does this by:

• setting and ensuring compliance with a wide range of technical requirements, such as maintaining acceptable voltages and power system frequency;
• ensuring investment in the transmission grid is timely and adequate to meet anticipated needs, which are determined according to minimum standards and/or a cost-benefit test;
• ensuring electricity demand can be met at all times without an emergency conservation campaign except in very dry years (worse than a 1-in-60 year drought).

The gas market is overseen by the Gas Industry Company (GIC), which is charged with ensuring improved gas market arrangements are developed and implemented.

3.1.5 Dry-Year Security

The EC has a number of tools to achieve its objectives for dry-year security, including securing additional reserve energy (either generation or demand reductions) if it believes there are not enough resources to deliver the required security standard. This regulatory backstop provides a high level of confidence that the specified security standard will be achieved, but does not guarantee power will never be interrupted.

An important feature of the electricity market is that the wholesale spot prices at which electricity is bought and sold every half hour can increase dramatically when supply becomes tight. For example, in March 2006, spot prices averaged more than 20c/kWh, compared with the annual average spot price in the year to September 2006 of 6.4c/kWh. The high prices coincided with low hydro storage levels, following an unusually dry spring and summer.

Price movements have an important role to play in maintaining a secure power system. When prices rise above a certain point, some consumers reduce consumption, making more electricity available for consumers who place a higher value on it. In this way, security of supply is inextricably linked to the price faced by participants in the market. High prices also give an incentive for investment in additional generation capacity.

Despite these regulated backstop measures, increases in spot prices during dry periods and other periods of tight supply can create a perception that the electricity system is fragile or less secure than it is. In consequence, the government continues to monitor and review the regulatory arrangements for the electricity sector, especially as they relate to supply security.

3.2 The Progress We've Made

3.2.1 Encouraging Effective Competition and Investment

The government and its regulatory agents are vigilant about ensuring there is effective competition in the market, by monitoring behaviour and continuously improving the transparency of market arrangements.

The government has taken steps to reduce uncertainty in the supply of gas. It has led the renegotiation of the Maui gas field contract to ensure there are incentives to explore and develop the field's remaining gas, and has amended the royalty and taxation regime for petroleum exploration and production to improve incentives.

To improve arrangements governing investment in transmission and distribution networks, the government recently issued revised policy statements to the EC and the Commerce Commission that reflected the importance of security of electricity supply - particularly transmission. The Government Policy Statement (GPS) on Electricity Governance sets out the objectives and outcomes that the government wants the EC to work towards. The GPS outlines the government's expectations for the effective operation of the electricity market and identifies three priority areas:

• security of supply and reserve generation;
• priority investment in the transmission grid;
• hedge market arrangements and demand-side participation.

3.2.2 Transmission and Distribution Networks

A strong national grid structure is particularly important for energy security and diversity of supply. This is reflected in recent increases in capital expenditure by Transpower. While investment in the grid averaged less than $100 million per annum over the last decade, it climbed to over $300 million this year and is expected to increase further.

A full review of the regulatory control provisions in the Commerce Act is under way, with recommendations expected by the end of 2007. In particular, the review will consider how to maintain the incentives for lines businesses and Transpower to invest in new and upgraded lines and to improve quality, including line losses, while continuing to protect consumers from excessive prices.

3.2.3 Climate Change and Resource Management

The government is acting to reduce uncertainties about climate change policies by developing a series of initiatives and proposals for consultation, as discussed elsewhere in the draft strategy.

The RMA was amended in 2005 to improve consenting processes and to provide a wider and more flexible range of mechanisms for decision making. The government is developing a National Policy Statement and National Environmental Standards relating to transmission under the RMA to improve environmental outcomes, including increased certainty and protection for transmission assets.

Formal consultation on the draft national guidance for transmission is expected in 2007.

3.2.4 Gas Market Initiatives

New Zealand has a window of opportunity for finding more local gas. New gas discoveries would give investors and consumers more confidence that gas will be readily available and reasonably priced in the future.

The Minerals Programme for Petroleum, which came into force in January 2005, contains initiatives to reduce royalties and fund seismic acquisition. Both measures aim to increase petroleum exploration in New Zealand.

The government has given further encouragement to upstream exploration and development by removing tax disincentives on oil rigs and seismic ships (the "183 day" rule).

Appropriate gas market regulations have become increasingly important with the move towards more diverse gas supplies. Initiatives in recent years have included forming the GIC, which is the industry body under the co-regulatory governance model established for the gas sector. The GIC is responsible for developing and implementing improved gas market arrangements.

3.3 Our Choices

3.3.1 Electricity Market Arrangements

The government recently considered whether supply security would be improved by a return to more centralised decision-making arrangements in the electricity sector. It concluded that security might be improved, but at a cost. The preferred approach is to improve the current arrangements - especially in respect of dry-year security and the operation of the market.

Options currently being considered to improve security of supply in generation capacity include:

• the EC being more proactive in providing authoritative information on short- and long-term security of electricity supply;
• acquiring more reserve energy (such as standby generation or buffer zone hydro storage) to cover seriously dry years;
• acquiring and holding in reserve consented sites to allow new generation to be built within 12 months if this was required to improve security margins.

The need for effective competition underpins a number of policy objectives for the non-transport energy sectors. Wholesale market design issues and system operation are complex, usually highly technical and interlock with each other. As a general rule, they are best reviewed and determined by the appropriate specialist regulatory body, except where they raise or are connected to other higher-level policy issues, in which case it may be more appropriate for the government to look at the broad policy settings.

The government also intends to make it easier for electricity lines companies to invest in generation, increasing competitive pressures in the market. Lines companies entering the generation market will continue to face certain restrictions to ensure they have limited opportunity to unfairly leverage their position in existing lines service activities.

The government intends retaining some restrictions on the quantity of generation that lines businesses may own and on local-area retailing, but is considering several additional options to facilitate investment in generation and retailing. Specifically, these options include:

• raising the threshold at which corporate separation and arm's-length rules apply from 5 MW (or 2% of peak load) to 10 MW (and no percentage figure);
• making lines companies exempt from generation quantity restrictions, corporate separation and arm's-length rules (except accounting separation) where their investments are outside their own lines areas;
• exempting lines companies from retailing restrictions outside their own lines areas;
• allowing the same person to be permitted to be appointed to the boards of the separate companies, but requiring directors to publicly certify each year that the (remaining) arm's-length rules have been complied with;
• permitting cross-owned supply (generator/retailer) businesses to trade in financial hedges and spot energy.

3.3.2 Generation Sources

New Zealand has large quantities of fossil and renewable primary energy supplies. Investment decisions and the future price of electricity largely depend on the ability to access and the costs of using these resources.

Large hydro developments and the Maui gas field have historically helped to keep New Zealand's electricity prices lower than international averages. Using our local energy resources insulates our electricity prices from fluctuations in international fossil fuel markets.

New Zealand's renewable energy resources - geothermal, wind, hydro and, potentially, marine - are extensive and of a very high quality (see Chapter 4). New Zealand also has large fossil fuel reserves, with extensive lignite reserves and moderate coal and gas reserves. The total energy value of recoverable lignite reserves is 75,000 PJ - equivalent to 20 times the original energy content of Maui.

The most recent assessment of known gas reserves indicates enough indigenous gas supply for existing uses, including gas-fired generation, to 2016-2018. However, gas supply from fields currently operating may be less flexible than before because, unlike Maui, they are unable to vary production to enable large increases in gas extraction in dry years.

Several companies are exploring options for importing gas - CNG or LNG - to cover the risk of insufficient local gas discoveries and to put a cap on local gas prices.

Wind generation cannot always guarantee firm capacity at times of peak demand. It is also less able than other types of generation technologies to provide services such as rapid reserve response and frequency and voltage support.

The market share of wind power and other intermittent renewables is increasing but still provides only a small proportion of electricity demand. At current levels, wind generation is not yet a source of security of supply risk, but a significantly larger share of wind generation could make supply less secure at peak times unless the system had adequate reserve capacity in place.

Further study is required to understand how a greater market share of intermittent generation could best be managed. Options may include improved wind forecasting, increased demand response and more geographically dispersed development of new wind farms. Other longer-term measures may include encouraging a greater diversity of renewables technologies, along with measures to retain a strong national grid to allow electricity to flow from places where the wind is blowing to places where it is needed. Fossil-fuel-based back up generation would continue to be needed in the meantime.

The government is working to facilitate distributed generation. Distributed generation is expected to play an increasingly important role in meeting electricity demand as the cost of smaller-scale and new renewable technologies continues to decline. Distributed generation can also improve security outcomes, depending on its type and where it is located. It is important, therefore, that there are no unnecessary barriers to its development.

3.3.3 Gas Market and Availability

The gas market's transition from being dominated by the Maui gas field to sourcing gas from a number of fields has implications for the wholesale market. Traditionally, gas wholesale trades have occurred only sporadically, to meet over-supplies or under-supplies.

More robust wholesale market arrangements will be required to enable gas to be traded in a secondary market and enhance gas supply flexibility, which has diminished along with the depletion of Maui. The GIC has been charged with developing and implementing new gas wholesale market arrangements and is scheduled to make a recommendation on new arrangements in mid-2007. It has also been charged with developing and implementing improved gas transmission arrangements. These arrangements will support gas trading and allow gas to be sourced and transported to customers from a number of different fields.

A national gas outage can have a negative impact on public safety, social or economic wellbeing. Contingency arrangements and processes are in place to minimise the impact of such an emergency, including the industry prepared and tested National Gas Outage Contingency Plan (NGOCP). The GIC is reviewing the NGOCP to ensure it is fit for purpose, given open access and the changing gas market.

3.3.4 Demand-Side Response

Demand-side response is electricity consumers' ability to respond to variations in market prices. High spot prices can send signals to consumers to use less electricity, use electricity at less expensive times, or switch to another energy source.

The demand-side response to price and choice of alternate stationary energy sources contributes to achieving security of electricity supply. In the short term, demand-side response is about price response, focusing on when energy is used and how much it costs. This can occur through demand-side participation in the interruptible load market or in response to price spikes.

Over the longer term, demand-side management generally involves investments that reduce or shift load permanently to reduce the need for transmission or generation investment.

Demand-side response plays an important role in competitive markets. Without some demand-side response potential, electricity markets could be more prone to supply failure, price volatility and market power abuses when supply is tight.

The level of demand-side response currently provided by the market is likely to be well below its full potential. In New Zealand, price signals are considerably muted for residential customers and business customers on fixed-price contracts. Levels of innovation and institutional arrangements to promote demand-side management remain weak, and further work is required to strengthen them.

3.4 Into the Future

Non-transport energy consumption is growing, and long-term security will depend on competitive market mechanisms, a cost-effective demand-side response, greater use of renewables and a strong national grid.

Existing initiatives are likely to prompt more investment in generation by lines companies, while incentives to increase petroleum exploration in New Zealand may result in significant gas and oil discoveries.

The gas market's move to more robust wholesale market arrangements will enable gas to be traded in a secondary market and will increase the flexibility of gas supplies.

The increasing pace of international research into new technologies and practices should enable New Zealand to make more use of its abundant renewable energy sources. Advances in geothermal, wind and hydro resources are likely, with wind in particular expected to be able to take up a greater share of generation