Further Government Decisions On Reserve Energy

Background

On 20 May 2003, the government announced its intention to create an Electricity Commission to govern the electricity industry and to improve security of supply. The government’s preferred mechanism for achieving improved levels of security is for the Electricity Commission to contract for reserve energy. A discussion paper on the issue was released and submissions have been received and considered. The Government has now made further policy decisions on the operation of the reserve energy scheme. The key features of the scheme are set out below. Some further detail is contained in the draft Government Policy Statement on Electricity Governance.

Purpose of reserve energy

The Electricity Commission will contract for reserve energy to help ensure New Zealand's electricity needs can be met even in very dry years without power savings campaigns. Current market arrangements do not provide sufficient incentives to hold energy in reserve for extreme circumstances, but greater security of supply is required for sustainable economic growth.

Reserve energy (and related initiatives such as improving the availability of market information) should also help reduce the extreme price volatility in the electricity spot market in dry years.

Different options for reserve energy

The Commission is expected to contract for low fixed cost options for reserve energy, which will tend to have high variable costs. This approach should minimise the overall cost of reserve energy, given that it is likely to be required infrequently.

New generation plant and plant that would otherwise be mothballed or retired will both be eligible to be considered for reserve energy. Existing plant can be considered for reserve energy even if it would not otherwise be mothballed or retired, but the Commission must consider the effect on competition and electricity security.

In addition, the Commission may contract with large electricity users for demand reductions as part of the reserve energy portfolio.

The Commission will develop and implement a clear process for assessing competing offers of reserve energy.

Limit on the quantity of reserve energy

The Commission will be able to contract for reserve energy up to a maximum of 1200 gigawatt-hours (GWh) over a four month period. This roughly corresponds to the difference in hydro supply between a 1-in-10 and a 1-in-60 dry year. It is equivalent to around 400-500 megawatts (MW) of thermal plant and/or load.

This cap will limit the total cost of reserve energy and should minimise any impact on incentives for investment in ordinary generation.

Ring-fencing reserve energy

Generation plant that has been ring-fenced as reserve energy will be available to protect electricity security, but not for other purposes. This will minimise any impact of reserve energy on incentives to build ordinary generation facilities.

Trigger mechanism

As a general rule, reserve energy will enter the market once the electricity wholesale spot price reaches 20 cents per kilowatt-hour (c/kWh). By way of comparison, spot prices are likely to average around 6 to 7 c/kWh over time, although they tend to rise as dry weather conditions reduce hydro lake levels. This means that reserve energy will be “triggered” (i.e. will operate) infrequently.

Reserve energy will also be triggered whenever the Commission determines that minimum hydro storage thresholds have been breached and there is a clear threat to electricity security, even if prices have not risen to 20 c/kWh. The Commission will be required to consult widely in developing minimum hydro storage specifications.

Whirinaki power plant

The Crown announced in July this year that it would purchase a new 155MW power plant before winter 2004 to increase electricity security. The plant is likely to be situated at Whirinaki, Hawkes Bay, although alternative sites are still under consideration. The Electricity Commission will be required to include this plant in its portfolio of reserve energy.

Levy to pay for reserve energy

The costs of the Whirinaki plant will be recovered by way of a levy on all wholesale purchases. The costs of additional reserve energy will be recovered initially in the same way, but the Commission will be required within two years to consider whether an alternative levy structure would produce a fairer and more efficient outcome. In particular, the Commission will investigate whether levy exemptions should be granted to those who have made their own arrangements for reserve energy.

Managing internal conflicts of interest

The Electricity Commission will be required to put in place sound arrangements to manage potential conflicts between its roles as regulator and as a participant in the market as contractor for reserve energy.

14 September 2003

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