Trends in the New Zealand Electricity Market

1. Trends in the New Zealand Electricity Market Christopher Russell Chief Executive

2. Overview • Update on trends and developments in the New Zealand electricity market • The demise of a self regulatory regime, and • The move towards heavy handed regulation • A cunning plan • Reserve generation • Long term impact on the market

3. Topic 1 – Update on Trends

4. Current Governance structure • Three voluntary governance arrangements • NZEM – wholesale spot market – operational since 1996 • MARIA – covers metering, reconciliation and bilateral trades – established in 1994 • MACQS – to cover security and quality of electricity transported across the grid – established in 1999 but not operational • Eight Service Providers • Market based on LMP • Annual traded volume through NZEM – 28,862 257 mWh • Amount paid by purchasers – NZD 1,439,229,956

5. Single Governance • Labour Government commenced a review of the industry in 2000 • Review recommended a single Governance structure • Industry Commenced a project in December 2000 “EGEP” to establish a self Governance structure • Mandatory Pool • Consumer voting rights • Operationalise MACQS • EGB rules went to vote on April 2003 and failed to obtain a majority • Government exercised its powers under the Electricity Amendment Act 2001 to establish the Electricity Commission

6. The Electricity Commission • It is a Crown Entity, with six independent Commissioners • The original plan called for the EC market to “go-live” by 1 October 2003, that is now planned for 1 February 2004 • The commencement market rules are largely based on the EGB rules but the Commission has additional responsibilities, above and beyond running a market as set out in a GPS • require generators to offer long-term hedges • responsible for ensuring modelling and forecasting of future supply and demand • require additional information disclosure • address transmission investment • Now lines Companies will be able to own unlimited reserve generation

7. Other issues • Adoption of the EGB rule book means that the EC market will be a Gross pool - problematic • The EC is required to ensure security of supply in dry year (one in sixty)

8. How did we get to this point - lessons • Lack of ongoing reform • Vertical integration stifled the development of a hedge market and retail competition • New Zealand’s exposure to dry year risk (hydro with only 16 weeks storage) • Government a major player in the industry • The “political” cap price

9. Topic 2 – Solution = Reserve Capacity

10. Government Approach to RG • The Government’s view appears to be: • Markets under-provide security of supply • Financial interventions are inadequate to assure security of supply • A ‘bricks and mortar’ approach provides the best assurance of security of supply • The Government’s policy is to require the EC to • Operate to a ‘1 in 60’ dry year security standard • Achieve this by contracting for reserve generation capacity and fuel • Withhold reserve generation from the market until dry year conditions are likely • Fund financial deficits of RG with a levy

12. Forecasting Energy Gaps • Energy modeling and forecasting will now play a critical role in dealing with dry year situations • But strong incentives for forecasters to over-estimate RG requirements • Impose high levy costs on consumers – perhaps involve consumers in setting RG quantities • Critical for the EC to set up modeling and forecasting arrangements appropriate for meeting its new responsibilities

14. What price level for intervention? • Efficient to set intervention price at LRMC • Could price at SRMC if RG deficits funded with hedge contracts • However the Government has determined to set the price at $200 per MWh • Serious risk of crowding out ordinary investment in mid-load and peak-load capacity, and stifling the hedge market • Sets a price cap • Imposes administration and compliance costs on consumers

15. Committing to the Intervention Price • EC may face strong pressure to ratchet-down intervention prices • Difficult to resist intervention when RG sitting idle and consumers are hurting badly from high spot prices • Generators may be viewed as gaming the system • Credibly committing to intervention prices or intervention formulae is critical for minimising displacement of ordinary generation and distorting the market

17. Method of Contracting for RG • Intention is for RG contracts to pay separate prices for capital costs, O&M costs, and fuel costs • Hence, selecting RG suppliers requires trading-off capital costs against variable costs • May not always be obvious who should win the contract • May create opportunities for bidders to undertake significant influence activity • Real risk that least-cost projects will not be chosen

18. Contracting Requirements • Tender and contracting processes • Need competitive and transparent tender processes • Need sophisticated and transparent cost-benefit modeling to compare proposals • Need detailed guidelines and audit trail for contract negotiations • Allow demand side participation in RG tenders • Embedded generation • Sellback of forward contracts

20. Funding RG with A Levy • The intention is to partially fund RG with a levy. If impose a levy then • Levy should be on energy consumed • Should collect levy from retailers and wholesale consumers • Funding RG with a levy would seriously diminish hedge market activity and incentives for self innovative provision of firm capacity • Need to exempt consumption supplied from (1) self-generation and (2) firm capacity contracts • Failure to provide exemptions leaves these consumers paying twice for their electricity