Security of Supply
Background
25. 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.
26. There are two key components to improving security of supply.
27. Firstly, we need to manage the risks of dry hydro years better than we have in the past. New Zealand has a high reliance on hydro generation, but has relatively little hydro storage capacity and variable inflows. This requires hydro lakes to be managed in such a way that the risks of running out of water are minimised, while at the same time ensuring that we make best use of the hydro resource and minimise unnecessary spill of valuable water. It also requires thermal generation to have secure availability of fuel, and to operate when required to supplement hydro generation and preserve hydro lake levels.
28. Secondly, continuing increases in demand for electricity mean we must build new plant on a regular basis. A long run average of 2% per annum increase in demand would require new generation to be able to supply an additional 800GWh each year, which on average requires about 150MW of new capacity.
Security of Supply Objective for the Electricity Commission
29. The Government wants the Electricity Commission to use reasonable endeavours to ensure security of supply in a 1 in 60 dry year, without assuming any demand reduction from emergency conservation campaigns, while minimising distortions to the normal operation of the electricity market.
30. The Commission may find it useful to develop and publish an operational security standard, possibly expressed as a loss of load expectation.
31. In order to aim for this standard, 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.
32. The Commission should consult widely in developing the minimum hydro zone.
33. 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 event.
Transparency
34. The Electricity Commission should develop, consult on and publish a security policy. The security policy should include the operational rules that are triggered during a contingent event such as an extended dry sequence. It should also include any procurement procedures for reserve generation and/or co-ordination tenders (see below). The overriding objective is to give as much certainty as possible to the market.
Good Processes
35. 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 sound arrangements to manage potential conflicts between its roles as a participant in the market, for example as a contractor for reserve capacity, and as a regulator.
Reserve Energy
36. The Government wants the Electricity Commission to contract for reserve energy (generation and interruptible load) to provide additional security beyond the level achieved by the ordinary market. This will be a primary mechanism for the Commission in endeavouring to extend system security to a 1 in 60 level.
37. The Government intends that the mechanism should operate as follows:
Quantity and Type
38. The Electricity Commission should procure a maximum of 1200GWh in energy over a four month period. Transmission constraints and other relevant factors need to be taken into account in assessing the effective contribution of reserve energy to conserving water in a dry year.
39. 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 high load-factor capacity, enter into hedge and other contracts, and invest in demand-side management.
40. The Electricity Commission should look out 3 to 5 years (given consent and construction timelines for new capacity), collect information, develop a baseline and identify any "shortfalls" year by year. It should contract for reserve energy to meet any shortfall up to the maximum specified above.
41. In contracting for reserve energy, the Electricity Commission should, as best it can, aim to minimise the long term costs of the reserve energy scheme, taking into account all relevant factors including the additional flexibility provided by short term contracts.
42. Generation plant that is ring-fenced as reserve 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.
43. 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.
44. Interruptible load may be contracted for as reserve energy.
45. The Commission should develop and implement a clear process for assessing competing offers of reserve energy.
46. The Commission should seek to minimise the impacts of the reserve energy scheme on the "ordinary" market. The Commission should initially adopt a tight ring-fence whereby reserve energy may be used only for security of supply objectives. This will minimise the extent to which incentives to invest in ordinary generation and demand-side management are affected. However, the Commission should review the ring-fence policy after three years, and if it finds there are net benefits (after consultation and considering any reduction in dynamic efficiency) recommend to the Minister of Energy that the policy be relaxed.
47. The Government has entered into contracts for the purchase and commissioning of 155MW of open cycle gas turbines for use as reserve generation for winter 2004 and beyond. The Government intends that the contracts it has entered into for the operation of this plant should be taken over by the Electricity Commission as part of the reserve energy mechanism, and that the full purchase and operational costs of the plant should be recovered by the Commission (as provided for in the Levy section below) and paid to the owner (the Crown). The Government intends to legislate to this effect.
48. For the avoidance of doubt, the Government does not want the Electricity Commission to own reserve generation plant.
Trigger Mechanism
49. 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.
50. However, if the minimum hydro zone referred to above is breached the reserve generation may be offered for dispatch at a lower price to ensure that it operates (if for unexpected reasons spot prices are lower than 20c/kWh). In this event the Commission should investigate the reasons why spot prices have not risen above 20c/kWh and consider what changes, if any, would be desirable.
Levy
51. 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 by way of a levy which is administratively simple and applies to all consumers based on wholesale purchases on an equal basis.
52. Within two years, the Commission should advise the Minister of Energy whether an alternative levy arrangement would produce a fairer and more efficient outcome. In particular, the Commission should investigate whether levy exemptions should be granted to those who have made their own arrangements for reserve energy.
53. It is likely that the levy will over or under recover the Commission's costs in any one year. Over time, however, the Commission should aim to balance its costs for reserve energy and levy revenues.
Regulations
54. 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 amending the Electricity Act to allow the Minister of Energy to recommend regulations specifying the key operational parameters of the reserve energy mechanism.
55. The Electricity Commission will have the power to recommend amendments to the regulations, and the Government will seek a report from the Commission after 12 months on the efficiency of the reserve generation mechanism in meeting security of supply objectives while minimising distortions to investment incentives in the ordinary market.
System Co-Ordination
56. 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 where required. Risks of inadequate system co-ordination will need to be monitored and managed by the Electricity Commission.
57. Introduction of the reserve energy scheme may also impact on system 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. Equivalently, thermal generators might decide to procure less fuel.
58. 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.
59. 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 manage the market 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 standard;
- using the proposed additional powers in the Electricity Act to recommend regulations or rules to:
- set minimum requirements on generators to hold or provide for reserve capacity and fuels;
- set requirements on generators to offer minimum levels of contracts to buyers. (This incentivises generators, if those contracts are taken up, to hold sufficient capacity and fuel to meet those contracts or to cross-insure with other generators for this purpose);
- set requirements on retailers and direct buyers from the grid to maintain minimum levels of contract cover with generators or firm demand-side arrangements.
Conservation Campaigns
60. 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 high risk of shortages (for example in a greater than 1 in 60 dry year). In this event, the Government expects the Commission to activate an effective conservation campaign in a timely manner, since conservation is significantly less damaging to the economy and disruptive to consumers and public welfare than actual blackouts.
Use of Ripple Control of Hot Water Heating
61. The Commission is expected to recommend regulations and rules allowing it to require and set terms and conditions for the use of ripple control of hot water heating, as a contingency for use if conservation campaigns are required, and as a measure to temporarily reduce demand in the event of an unexpected event such as an unplanned plant or transmission line outage.
Co-Ordination of Outages
62. The Commission is also expected to recommend regulations and rules to give it contingency powers to require, schedule and set terms and conditions relating to rolling outages in the extreme event that blackouts are required to ensure a balance between supply and demand.
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