Security of Supply
Background
35. A key priority of the Government is to improve security of electricity supply. Shortage risks occurred in 2001 and 2003, resulting in sustained high spot prices and the need for emergency conservation campaigns. This has caused inconvenience and disruption, and may have affected the attractiveness of New Zealand for business investment, especially for sectors using relatively large quantities of electricity. In the Government's view, security of supply is vital to achieving its objective of sustainable economic development.
36. Key components of security of supply are that:
- Sufficient generation capacity is built or energy efficiency improvements made to meet ongoing demand growth
- Hydro and thermal generating capacity and fuels are appropriately managed, to deal with the risks of extended dry hydro periods better than we have in the past
- The system has sufficient reserve energy (plant and fuel, or contracted demand response) to cope with extreme dry sequences or other unexpected supply disruptions
- The national grid and distribution lines meet specified reliability objectives. (Transmission and distribution issues are covered in separate sections).
Security of Supply Objective for the Electricity Commission
37. A function of the Electricity Commission under the Electricity Act 1992 is to use reasonable endeavours to ensure security of supply, without assuming any demand reduction from emergency conservation campaigns, while minimising distortions to the normal operation of the electricity market. In particular, the Government wants the Commission to use reasonable endeavours to ensure security of supply in a 1 in 60 dry year. The Commission should also work with stakeholders to identify industry contingencies and develop strategies consistent with the operation of the electricity market to achieve its security of supply objectives.
Information, Modelling and Forecasting
38. The Commission should undertake and publish detailed supply and demand modelling and forecasting at least annually. The objective is to provide well-researched information on short and long term security of supply, including likely availabilities of fuels, new generation options, and likely price trends under various scenarios.
39. The Commission should ensure that public information is provided on:
- thermal fuel availability
- hydro lake levels
- hydro spill
- generation capacity.
40. To establish the need for additional reserve energy (see below), the Electricity Commission should look out 3 to 5 years in more detail (given consent and construction timelines for new capacity), collect information, develop a baseline that makes assumptions about what known projects are likely to proceed, and identify any "shortfalls" year by year. The need for additional reserve energy should be based on dry year risk taking into account prudent assumptions about availability of other plant.
Security of Supply Policy
41. The Electricity Commission should develop, consult on and publish a security of supply policy. The security of supply policy should specify the steps that the Commission will take at various stages during a contingent event such as an extended dry sequence. It should also include its procurement policies for reserve energy. The overriding objective is to give as much certainty as possible to the market.
42. The Commission should develop and publish an operational security of supply standard, possibly expressed as a loss of load expectation.
Minimum Hydro Zone
43. To help ensure security of supply, the Electricity Commission should develop and publish a minimum hydro zone giving its estimate of minimum hydro storage levels required at different times of the year to avoid the risk of shortages in a 1 in 60 dry year. This minimum zone should take into account the expected availability and use of thermal generation. The minimum hydro zone should not be catchment-specific but should be national or based on regions defined by likely transmission constraints during a dry hydro period.
44. The Commission should consult with interested parties in developing the minimum hydro zone.
45. Within this minimum zone, the Electricity Commission should have a second zone that would trigger a conservation campaign, on the basis that there is a significant probability that we are in a worse than 1 in 60 dry year event.
Good Processes
46. In developing and operating its security of supply policies, the Commission should:
- put in place good consultation processes
- ensure a high level of transparency and stability of policy settings
- avoid ad hoc and discriminatory interventions
- put in place and publish protocols to manage potential conflicts between its roles as a participant in the market as a contractor for reserve energy and as a regulator.
Reserve Energy
47. The Government wants the Electricity Commission to contract for reserve energy (generation and contracted demand response) to provide additional security of supply beyond the level achieved by the ordinary market. This will be a primary mechanism for the Commission in endeavouring to ensure security of supply in a 1 in 60 dry year. Any reserve energy procured to ensure security of supply in a 1 in 60 dry year should also be available to help cope with other unexpected supply contingencies, such as serious grid, plant or fuel supply disruptions.
48. The Government intends that the mechanism should operate as outlined below.
Quantity and Type
49. The Commission's portfolio of reserve energy should be limited so that it is capable of producing no more than 1200GWh of reserve energy over any given four month period. Transmission constraints and other relevant factors need to be taken into account in assessing the effective contribution of reserve energy to ensuring security of supply.
50. The reason for a firm maximum quantity is to ensure market participants have certainty as to the maximum role of the Electricity Commission in providing for reserve energy, and to minimise the risk of reserve energy affecting incentives for market participants to construct new capacity, enter into hedge and other contracts, and invest in demand-side management.
51. In contracting for reserve energy, the Electricity Commission should, as best it can, maximise static and dynamic efficiency. It should also take into account the additional flexibility provided by short term contracts.
52. Generation plant that is contracted as reserve energy should primarily comprise plant with low fixed costs and high operating costs, including plant that would otherwise have been mothballed or retired, rather than baseload plant.
53. In deciding whether to contract with existing plant, the Commission should take into account:
- the benefits of lower cost to the reserve energy scheme; and
- the potential detriments to security of supply and competition in the "ordinary" market before replacement generation is commissioned.
54. Contracted demand response should form part of the Commission's portfolio of reserve energy, provided this is practicable, and the Commission is confident that the reduction in demand is additional to normal demand-side responses to higher prices.
55. The Commission should develop and publish its processes for procuring reserve energy including its processes for assessing competing offers of reserve energy.
56. The Commission should seek to minimise the impacts of the reserve energy scheme on the "ordinary" market. The Commission should adopt a tight ring-fence whereby reserve energy may be used only for security of supply objectives, with the exception of distributed generation used for distribution network load management.9 This will minimise the extent to which incentives to invest in ordinary generation and demand-side management are affected.
57. Contracts with reserve energy providers should provide for fixed payments for availability and variable payments when the reserve energy is called upon. Any spot price revenue received during operations should go to the Commission and be used for reducing reserve energy and other levies.
58. The Government has built a155MW power station at Whirinaki for reserve energy use. Pursuant to the Electricity Act 1992, this power station will be available to the Electricity Commission by contract for the purpose of reserve energy.
59. For the avoidance of doubt, the Government does not want the Electricity Commission to own reserve generation plant.
Trigger Mechanism
60. Reserve energy should be offered for dispatch to the system operator at 20c/kWh or the variable payments which have been contracted for, whichever is the higher.
61. However, if the minimum hydro zone is breached reserve energy may be offered for dispatch at a lower price to preserve hydro storage. If the minimum zone is breached and all available thermal generation is not being used to minimise hydro usage, the Commission should investigate the reasons and consider what action, if any, would be desirable.
Levy
62. The Commission is expected to recover some of the costs of contracting for reserve energy from spot market revenues when reserve generation operates. However, net costs should be recovered initially by way of a levy which is administratively simple and applies to all consumers based on wholesale purchases on an equal basis. (The levy should be reviewed as part of the overall review noted below).
63. Over time, the levy will aim to recover the net costs the Commission incurs for reserve energy (that is, operating and capital payments less any revenue received from the sale of reserve energy).
Regulations
64. As noted, the Government considers it particularly important that the way the reserve energy mechanism operates should minimise any adverse impacts on incentives for investment in ordinary generation, demand side management, and management of price risks. Accordingly, it proposes to help provide regulatory certainty by specifying the key operational parameters of the reserve energy mechanism in regulations so that changes to those parameters can be made only by regulation. Furthermore, changes will be able to be made only on the recommendation of the Commission.
Review
65. The Electricity Commission should contract an independent third party to review the efficiency and effectiveness of the reserve energy policy in meeting security of supply objectives while minimising distortions to investment incentives in the ordinary market. Efficiency should include both static and dynamic efficiency. The review should take into account developments in other areas of security of supply policy such as security of supply co-ordination policy (see below).
66. The review should consider whether it is appropriate to relax the tight ring-fencing policy after considering any reduction in dynamic efficiency that this might create. The review should also recommend whether alternative levy arrangements would produce a fairer and more efficient outcome. In particular, it should investigate whether to allow for some element of self-provision of security of supply with an associated exemption from the levy, and if so whether the extent of any self-provision should be audited by a body independent of the Commission.
67. The review should provide an opportunity for public consultation, and should make recommendations to the Commission by 31 December 2006. The Commission should consider the report and make recommendations to the Minister of Energy by 31 March 2007.
Security of Supply Co-Ordination
68. A key requirement for the secure operation of the New Zealand system is that hydro lakes are managed optimally to use as much water as possible while avoiding the risk of running out of storage, and that thermal plants have adequate fuel and operate in a timely manner to complement hydro generation and preserve lake levels when required. Risks of inadequate security of supply co-ordination will need to be monitored by the Electricity Commission.
69. Introduction of the reserve energy scheme may also impact on security of supply co-ordination. A risk is that (for example) hydro generators may observe the reserve energy and decide to run their lakes lower than they otherwise would have, or thermal generators might decide to procure less fuel.
70. The Commission should seek to minimise these risks by compiling and publishing high quality information, including on hydro lake levels, thermal fuel availability, scheduled plant and transmission outages and minimum hydro zones.
71. The Commission is also expected to be active in monitoring developments, using the powers available to it, and, if necessary, making recommendations to the Minister on any further powers it believes to be necessary to ensure the market operates efficiently. This may involve:
- undertaking "co-ordination tenders" to incentivise (via payments) a combination of hydro storage and thermal fuel that is sufficient to achieve the security of supply standard over a short term timeframe (e.g. one year)
- using the proposed additional powers in the Electricity Act 1992 to recommend regulations or rules, which should be applied in a non-discriminatory manner, to:
- set minimum requirements on generators to hold or provide for reserve fuels (including water)
- set requirements on generators to offer by tender a minimum volume of contracts that enable the price risks associated with the spot market to be managed, including requirements relating to the terms and conditions of those contracts (excluding prices and reserve prices). This would incentivise generators, if those contracts were taken up, to hold sufficient capacity and fuel to meet those contracts or to cross-insure with other generators for that purpose
- set requirements on retailers and other direct buyers of electricity from the wholesale market to maintain minimum levels of hedge and contract cover with generators and/or minimum levels of demand-side management programmes and contracted demand response.
Conservation Campaigns during Security of Supply Situations
72. Although the Government wants the Commission to manage the electricity sector to minimise the risk of supply shortages, it recognises that there will be infrequent circumstances where there is a material risk of shortages (for example in a worse than 1 in 60 dry year). In this event, the Government expects the Commission to activate a conservation campaign in a timely manner, since conservation is significantly less damaging to the economy and less disruptive to consumers and public welfare than actual blackouts.
Use of Ripple Control of Hot Water Heating during Security of Supply Situations
73. The Commission is expected to ensure contingency arrangements are put in place for the use of ripple control of hot water heating for use as appropriate if conservation campaigns are required, and as a measure to temporarily reduce demand in events such as major and unexpected plant or transmission line outages. The Commission should recommend regulations and rules if required. (The use of ripple control for these purposes should not preclude its use for other purposes outside of security of supply situations).
Co-Ordination of Outages during Security of Supply Situations
74. The Commission is also expected to put in place contingency arrangements to provide for the scheduling of rolling outages in the extreme event that blackouts are required to ensure a balance between supply and demand. The Commission should recommend regulations and rules if required.
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