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• 8. Security

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8.1 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 and a reliable supply of input fuels for electricity generation.

Maintaining security of supply at competitive prices is essential for a modern economy. The reliability of a power system is measured by the frequency and duration of supply interruptions. The power system must have sufficient equipment and management systems to minimise the possibility of short-term supply interruptions as a result of equipment failure, the weather, operational error and other factors.

The long-term security of supply requires:

• building enough generation capacity to meet peak demands
• ensuring there is enough fuel (taking into account the uncertainty of hydro inflows and wind flows) to generate sufficient electricity at all times
• building and maintaining a transmission system to convey power from generation plants to consumers, particularly at peak times
• making the most of cost-effective energy efficiency opportunities.

8.2 Factors Affecting Security

New Zealand's electricity system has a number of characteristics that have implications for security of electricity supply:

1. The electricity system is dominated by an existing stock of hydro generation, which typically produces
   60 per cent of total electricity supply annually. The amount of hydro electricity generated depends on the level of rainfall in the catchment areas feeding the hydro lakes (see Figure 8.1).
2. Main hydro stations are a long way from the main demand centres.
3. New Zealand cannot import or export electricity, which tends to make market outcomes more volatile.
4. Our market is small, so the preferred economic scale for new generation is large relative to the size of the system and the annual increase in demand.

Figure 8.1: New Zealand's Electricity Supply ³³

Source: Concept Consulting Ltd

New Zealand's supply security, in the context of hydro variability, has been managed by building thermal generation stations using fossil fuels such as coal, oil and natural gas. However, there has never been enough fossil fuel generation capacity to completely remove the risk of interruptions caused by hydro shortage. Instead, the power system has traditionally been managed to reduce the risk of a hydro shortage causing power interruptions. This has given us 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 cost and higher levels of security.

8.2.1 Energy Sources and Generation Options

New Zealand has substantial fossil and renewable primary energy supplies. Investment decisions and future electricity prices largely depend on our ability to access these resources and the costs of utilising them.

Large hydro developments and the Maui gas field have historically helped to keep New Zealand's electricity prices lower than international averages.³⁴ Using our local energy resources insulates our electricity prices from fluctuations in international fossil fuel markets.

The most recent assessment of known gas reserves indicates enough indigenous gas supply for existing uses, including gas-fired generation, to around 2016/18. However, gas supply from fields currently operating may be less flexible than before because, unlike Maui, newer fields are unable to vary production to enable large increases in gas extraction in dry years.

Several companies are exploring options for importing gas – compressed natural 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.

New Zealand has abundant geothermal resources, which can provide valuable baseload generation and, in general, produce far fewer emissions than fossil fuel-based thermal generation. However, geothermal generation does not usually have the flexibility to manage sudden variations that can occur with wind generation output, so it will not diminish the continuing need for some fossil fuel generation capacity.

8.2.2 Supply Security in a Market Context

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

In the current market arrangements, 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 short-term price rises. This can affect public confidence in current market arrangements.

In the near to medium term, planned generation is sufficient to ensure adequate generation capacity. The introduction of emissions pricing is not expected to reduce the amount of investment in generation, and is likely to increase investment in renewable generation.

Between November 2006 and August 2007, some electricity generators abandoned or deferred previously announced plans to invest in new fossil fuel generation plant and instead began working to develop renewable generation alternatives. This reflects their view of the relative future economics of renewable generation compared to fossil fuel alternatives, including emissions prices (see Figure 5.7 in Part 1).

Table 8.1 presents generation projects that have either been given consent or are under consideration. Not all will be built or given consent.

Table 8.1: Planned Generation Projects³⁵

1. Te Rere Hau Wind Farm is being commissioned in stages. The first five turbines (2.5 MW) were installed and operational from 2006, with a further 14 turbines (7 MW) due to be commissioned in late 2007.
2. Original consent application was for 108 MW with 127 turbines. However, resource consent reduced the number of turbines to 75 with a total capacity of 64 MW. Allco Wind Energy has appealed the decision.
3. New application. Original application was declined by the Environment Court.

Source: Ministry of Economic Development.

8.2.3 Supply Security with a Greater Proportion of Renewable Generation

Emissions pricing will increase the competitiveness of renewable alternatives and encourage investment. In the past, New Zealand has had a higher percentage of renewable generation (predominantly hydro).³⁶

A greater reliance on renewable generation has implications for the way security of supply is managed. Thermal plants such as Huntly will continue to play a critical role in New Zealand's electricity system, providing necessary security and versatility to both the provision of energy and the stability of delivery (voltage and frequency). Huntly, running on coal (or gas if it is available), is well positioned to provide dry-year energy security to the electricity market, particularly in autumn and spring. It could also provide market support during major generation plant or transmission maintenance outages.

Modelling shows that New Zealand could have up to 90 per cent renewables generation by 2025, based on current technology, without incurring substantial costs or reducing the security of supply (see section 9.3.2).³⁷This would be a significant advance on the current proportion of 70 percent.

8.2.4 Coordination of Generation and Transmission

In submissions on the draft NZES, there was widespread recognition that a strong and robust transmission grid was fundamental to implementing the strategy. Four issues emerged:

• major investment in the transmission grid is required to fulfil the NZES vision of a high renewables future
• differences in the lead-in time needed for transmission and renewable generation developments may make it harder to coordinate generation and transmission planning
• a high renewables mix will require a particular transmission grid formation, given intermittency – planning needs to start at an early stage
• much of the existing transmission infrastructure is old and urgently needs upgrading.

Figure 8.2: Location of electricity demand, supply and transmission grid

Source: Concept Consulting Ltd

It is important that decision-making processes around transmission planning and investment are coordinated, to allow the most efficient use of available and planned generation resources. Although the framework for grid planning is reasonably well established in the GPS on Electricity and Part F of the Electricity Governance Rules, the detailed planning processes, policies and guidelines are still being developed by the EC. The government expects the EC and Transpower to continue to develop guidelines that recognise the importance of transmission for investment in renewable generation.

8.2.5 Oversight of Supply Security

The Electricity Commission is responsible for ensuring that the power system is 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)³⁸
• promoting and facilitating the efficient use of electricity.

The gas market is overseen by the GIC, which is responsible for developing and implementing improved gas market arrangements.

8.2.6 Managing Dry-year Security in the Market Context

The EC has a number of ways to ensure the New Zealand electricity system has dry-year security, including securing additional reserve energy (either through additional generation or demand reductions) if it believes there are not enough resources to deliver the required security standard. This regulatory back-stop gives a high level of confidence that the specified security standard will be met, 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 very low hydro storage levels following an unusually dry spring and summer.

Price movements play an important role in maintaining a secure power system. When prices rise above a certain point, some consumers use less power, making more electricity available to 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 a signal to maximise available output and for investment in additional generation capacity.

In 2006, the government evaluated alternatives to the current market arrangements and concluded that, while alternative arrangements might provide higher levels of security, these would come at a cost. The government's preferred approach was to retain and improve the current arrangements – especially in respect of dry-year security and the operation of the market.

If the market moved to a more peak-constrained rather than more energy-constrained situation in future, the EC would be expected to revise the reserve energy policy.

8.2.7 Role of Fossil Fuel Power Stations

Fossil fuels will continue to play a critical role in meeting New Zealand's energy supply requirements as we make the transition to a sustainable energy future. Where fossil fuels are required, preference will be given to the lowest carbon-emitting indigenous energy supply, gas in preference to coal and distillate, and for security reasons, indigenous resources in preference to imports.

As demand is increasingly met by renewables, the role of fossil fuel generation could change as follows:³⁹

• Peaking plant: Modelling projects a need from 2020 onwards for new peaking plant for security reasons to ensure that peak demand can be met as reliance on intermittent generation increases
• Baseload thermal: Modelling indicates lower load factors for fossil fuel baseload and mid-range plant as the volume of renewable generation increases.

The load factor of peaking plant is low, indicating that this plant is likely to be required only infrequently, except in rare and unexpected circumstances. Consequently, expected emissions from this plant are low. However, construction and funding of such significant quantities of low utilisation plant are likely to require further consideration of market arrangements to ensure that the appropriate investment incentives are in place.

8.2.8 Role of Demand-side Response

Demand-side response is a way of describing electricity consumers' ability to respond to variations in market prices. To date, demand-side response has typically been limited to participating in the instantaneous reserves market, major electricity user response to high wholesale spot prices, use of ripple control technology to manage load at a regional level, and choices made as part of capital investment decisions.

Demand-side management capability generally requires capital investment. The cost of demand-side technologies continues to fall, and understanding of demand-side technologies is growing, as is the understanding of the structure of electricity prices to which demand can respond.

Demand-side response can play an important role in competitive markets. It can be an alternative to generation capacity to meet peaks, and avoid or delay the need for transmission and distribution investment. Within the New Zealand context, demand-side response is a cost-effective way to manage demand in dry years.

8.3 The progress we've made

8.3.1 Encouraging Effective Competition and Investment

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

It also issued revised policy statements to the EC and the Commerce Commission to reflect the importance of security of electricity supply – particularly arrangements governing investment in transmission and distribution networks.

8.3.2 Investment in Transmission and Distribution Networks

Transpower has recently increased its capital expenditure to upgrade and strengthen the grid. Investment in the grid has increased from $100 million per annum over the last decade to over $300 million in the year 2006/07, and is likely to increase to approximately $500 million per annum for the next five years.

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 is considering how to maintain the incentives for lines businesses and Transpower to invest in new and upgraded lines and to improve quality, including reducing line losses, while continuing to protect consumers from excessive prices.

8.3.3 Gas Market Initiatives

The New Zealand gas market is undergoing a period of significant transition, away from a market dominated by the Maui field to a market where gas will be sourced from a number of medium to small fields.

Initiatives in recent years have included forming the GIC. The Minerals Programme for Petroleum, which came into force in January 2005, contains initiatives to reduce royalties and fund seismic acquisition. 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).

The government believes these initiatives and the settings that they have created are generally appropriate.

8.4 Our Actions

8.4.1 Improving Market Arrangements

The EC is reviewing its reserve energy policy, which is currently based on the probability of exceeding a dry year inflow.

ACTION: The EC is reviewing its reserve energy policy and the government will consider whether additional measures are required.

Effective competition underpins a number of policy objectives for electricity and gas markets. As a general rule, wholesale market design issues and system operation are best reviewed by an appropriate specialist regulatory body – unless they are connected to other higher-level policy issues, in which case the government may need to look at the broad policy settings.

ACTION: The EC will continue its current work programme to advance wholesale market design issues. The Commerce Commission's investigation into the retail and wholesale electricity markets is expected to be completed in 2008.

The government will revise its policy statements on governance of the gas and electricity sectors to reflect the policy directions set out in this strategy. The revised policy statements will also be reissued formally to the Commerce Commission under the Commerce Act.

ACTION: MED will ensure that the government policy statements on the governance of the gas and electricity sectors are consistent with the directions of the NZES.

The government will reduce barriers to generation and related retailing by lines companies to increase supply-side competitiveness and renewable generation investment, while retaining controls against monopoly practice within local lines areas.

ACTION: The government will introduce amendments to the EIRA to relax some of the existing constraints on investment by lines companies by the end of 2007.⁴⁰

8.4.2 Managing Intermittent Renewable Generation

The market share of wind power and other intermittent renewables is likely to increase under emissions pricing and the introduction of the renewable electricity target. Wind generation is not a security-of-supply risk at current levels, but will need to be carefully managed as its share of total generation grows, to ensure security at peak times and to ensure the system has adequate reserve capacity in place. Options 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. Existing fossil fuel generation will continue to be needed to provide back-up in the meantime.

The EC has completed the first phase of a study of the long-term implications of increased wind generation on the electricity system (including scenarios incorporating up to 2,000 MW of wind by 2016). Preliminary results for this study have indicated a range of operational issues to be managed, but they are not expected to substantially hinder the economic development of New Zealand's wind resource. The EC's forward work programme will include developing the market rules and processes to manage higher levels of wind generation.

ACTION: The EC is overseeing the development of policies and processes to efficiently manage the frequency, voltage and reliability of the New Zealand generation and transmission system.

Distributed generation, especially in combination with advanced⁴¹ meters (see section 8.4.5), is expected to play an increasingly important role in improving the sustainability of our power supplies as the cost of smaller-scale and new renewable technologies continues to decline. Distributed generation can also improve security outcomes. The NZEECS will establish programmes to continue removing undue barriers to small-scale generation and to look at ways to encourage development.

ACTION: The government is promulgating distributed generation regulations to process connection applications on a more fair and consistent basis.

8.4.3 Facilitating Transmission Planning and Upgrades

A NPS on electricity transmission under the RMA is proposed to provide national direction on the sustainable management of the electricity transmission network. The national significance of the electricity transmission network is expected to be recognised when considering resource management proposals. A Board of Inquiry is considering submissions and is expected to make recommendations by the end of 2007.

Grid capacity improvements must pass the EC's Grid Investment Test (an economic cost-benefit test) to ensure that they contribute a national net benefit.

ACTION: The government will develop a NPS and two National Environmental Standards on electricity transmission by 2008.

8.4.4 Improving Gas Market Arrangements and Availability

Reduced gas supply flexibility, as a consequence of the depletion of the Maui field, could have a harmful impact on the efficient use of gas in the downstream electricity market. The GIC is working on a range of measures to improve gas supply flexibility and will make recommendations on improved arrangements in 2007/08. Principally, new gas wholesale arrangements will be developed and will be supported by improved gas transmission and distribution measures. As a package, these measures will support gas trading and allow gas to be sourced from different fields and transported to customers.

Contingency arrangements are in place to minimise the impact of a national gas outage, including the industry's National Gas Outage Contingency Plan (NGOCP). The GIC is reviewing the NGOCP to ensure it is appropriate.

ACTION: The GIC is developing gas wholesale and transmission market arrangements to establish more flexible and secure gas supply arrangements.

ACTION: The GIC is reviewing the adequacy of the current arrangements in the case of a national gas outage.

8.4.5 Improving Demand-side Response

Demand-side participation within the New Zealand market is probably not meeting its potential. Price signals are muted for residential customers and business customers on fixed-price variable volume contracts, and levels of innovation and institutional arrangements to promote demand-side management need strengthening. The EC has an ongoing work programme to improve demand-side response.

Another example of innovative work is Transpower's two-year trial demand-side programme, known as the Demand-Side Participation Project. The programme may allow Transpower to defer some transmission investment by using contracts to reduce peak electricity demand.

Smart meters will enhance the existing load management capability. To be fully effective, smart metering requires "smart" or innovative pricing. There have been concerns that current meter ownership arrangements are inconsistent with the deployment of smart metering technology. The EC will take account of these concerns when developing guidelines on smart metering under the NZEECS.

8.4.6 Enabling Lines Companies to Undertake Energy Efficiency Initiatives

Some lines companies have carried out energy efficiency initiatives, but others believe regulatory price controls create a disincentive to invest in measures that may lower energy volumes. A review is underway of the regulatory control provisions relating to incentives for lines companies and Transpower in the Commerce Act.

ACTION: The government is further considering the role of lines companies and retailers in delivering energy efficiency initiatives.

8.4.7 Reviewing Supplier Obligations

Section 62 of the Electricity Act 1992 provides that lines companies must maintain line services to connections established as at 1 April 1998. This section expires on 31 March 2013 and is to be repealed. The main consequence is that, following expiry, consumers connected to lines that are commercially non-viable face uncertainty about access to electricity at affordable prices.

This section of the Act is being reviewed in 2007 to reduce uncertainty before 2013. The aim of the review is to present a range of feasible options for consultation to ensure affected consumers continue to have access to electricity after 2013 and that it is delivered efficiently, fairly and reliably.

ACTION: The government is reviewing lines companies' supply obligations post-2013 and is consulting with stakeholders on options.

8.5 Into the Future

Long-term security depends on competitive market mechanisms, a cost-effective demand-side response, greater use of renewables and a strong national grid.

The introduction of emissions pricing is not expected to affect security of supply.

The future introduction of advanced meter protocols and the uptake of these meters, together with compatible appliances, will enable retailers to offer more innovative tariff structures, rewarding customers for timely demand responses.

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 use of geothermal, wind and hydro resources are likely, with wind, in particular, expected to be able to take up a greater share of generation.