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Hodgson: Electricity: issues for lines companies

Electricity: issues for lines companies

[Hodgson Address to Electricity Networks Association annual general meeting, Te Papa, Wellington]

Thank you for inviting me to speak again this year.

When I addressed your association last year, I noted that the previous twelve months had been very eventful, not the least because of an exceptionally cold, dry winter and the challenges that entailed. This year has also been eventful, albeit with a winter that was relatively mild and wet.

I would like to take this opportunity to comment on two issues of considerable significance to the electricity industry, and the economy, at large. Namely, security of supply and industry governance. Then I will discuss a range of issues of specific relevance to networks companies.

Turning first to security of supply. This is a very topical issue at the moment, and so it should be. As you will know, New Zealand’s demand for electricity has been growing at a steady rate of nearly 2% per annum for many years. If this rate of growth continues, we will need to build about 150 megawatts of new generation a year simply to meet demand and maintain an adequate dry-year reserve.

It is clear from the modelling done to date that New Zealand will need significant new generation capacity from about 2005 onwards, if we are to adequately cover the risk of a dry year.

You will no doubt be aware that Bryan Leyland of Sinclair Knight Merz, in association with the Centre for Advanced Engineering, just last week released a report predicting that New Zealand will have significant difficulty meeting its electricity requirements in a dry year from now on. This is in contrast to Transpower’s estimates, which suggests this point will not be reached until 2006/7 under a medium demand growth scenario of 2.2% per annum, or 2005 under a higher (2.6% per annum) growth scenario.

To make sense of the difference between the two models an independent assessment of the current situation was undertaken at my request by Tom Halliburton, an experienced energy modeller. Tom suggests Transpower errs on the side of optimism while Bryan errs on the side of pessimism.

Perhaps more importantly, Tom suggests that the limitations of both models are significant. I have subsequently asked officials to investigate the options for ensuring better quality modelling work becomes available soon.

Limitations of the models aside, these estimates have caused us to look hard at the factors affecting the security of our electricity supply over the next few years. The three most important issues are, the industry’s plans for new generation capacity, the availability of gas for electricity production, in particular New Zealand’s transition to a post-Maui future, and the level of demand-side response to a dry year situation. I will briefly address each of these in turn.

In theory, the market should deliver new generation capacity as and when required. However the electricity market, as we know it, is still in its infancy, and the interests of electricity companies are not the same as the national interest. I am not a Minister prepared to sit back and hope that sufficient generation will be provided in a timely manner.

Accordingly, I instructed officials to gather information from industry on current plans for new generation capacity. I am informed that there are potential plans for more than 2000 megawatts of capacity to be built in the next decade. This includes public plans such as Genesis’ gas–fired plant at Huntly, Meridian’s Project Aqua and a 39MW upgrade to the Mokai geothermal station, as well as many other plans that have been disclosed on a commercial-in-confidence basis.

I expect much of the new plant to be embedded within network systems, and as I shall come back to later, transmission and distribution pricing is crucial to determining the extent to which future electricity needs will be met in this way.

The second important issue for supply security is the availability of gas for electricity generation, especially in a dry year.

Gas currently fuels 22 percent of electricity generation in a normal hydrology year and significantly more in a dry year. Gas is likely to be a preferred fuel for new generating capacity if it is available long-term, even if the wholesale price rises significantly above the current low level set by Maui.

There are uncertainties over the volume of gas likely to be available in the future. It is not yet clear how much more Maui gas will be economically recoverable at the current contract prices. That is the subject of the current redetermination process, which is expected to be completed by the end of the year. Nor is it clear how much more Maui gas might be forthcoming at higher prices. We do not know how much gas will be taken after the Maui redetermination by Methanex, which currently uses around 40 percent of total gas consumption. We are not yet sure exactly how much gas will come from the Pohokura field, or when it will be available – although Shell recently said it might be one-third the size of Maui and bids could be sought from about March next year. We cannot know the timing, size, location and cost of new gas discoveries.

As Maui production tails off, many smaller gas fields – including a number already discovered, proved up and resource consented – will become economic. New Zealand will revert to a more typical supply situation in which gas is drawn from a larger number of smaller fields. Known reserves might typically stretch forward a decade or so, rather than Maui’s thirty years. Thirdly, the demand side, often overlooked in the past, is now a key factor in ensuring security of supply in the years ahead.

I don’t accept that demand for electricity should continue to grow as it has in the past. This is because I am convinced of the need for New Zealand to de-couple economic growth from growth in energy use by becoming more energy efficient. The Government is committed to a sustainable energy future. Building new generation capacity is not the only answer to meeting our energy needs.

With some exceptions, New Zealand’s energy efficiency record to date is poor. We waste hundreds of millions of dollars every year through inefficient energy use. There is definitely room for improvement. To this end, the Government has put in place New Zealand’s first National Energy Efficiency and Conservation Strategy. Further, the Energy Efficiency and Conservation Authority has been strengthened and given a much stronger ministerial mandate for its work.

We are pushing the energy efficiency and conservation message hard and getting up to speed with measures such as minimum energy performance standards, energy performance labelling and a building code that reflects the importance of good energy management.

Improved energy efficiency will give us added security in the medium to long term. Demand side responsiveness, the ability of large users to actively manage their energy needs, is of more immediate value.

I expect that more active load management in co-operation with large industrial and commercial customers will become a more established part of the industry’s contingency planning for dry years. Already we have seen the development since last winter of contracts that give big consumers a larger role in managing dry year risk by including an element of spot market exposure.

The choice for big consumers will increasingly be between cheaper power with an element of dry-year price risk and more expensive contracts with greater price stability. This also needs to become standard practice for a wider range of commercial customers.

Network companies have a central role in providing load management services to electricity retailers for all customers. But while we have seen some investment in systems for load management, these have been mainly for the very large industrial customers. There appears to have been little or no investment in respect of smaller customers beyond basic ripple control. With the wholesale market moving towards better real time signalling and the tightening of supply, now may be a good time to look at what other innovations in this area are possible.

It may be that distributors, which will often have longer term relationships with customers than retailers, have a larger role to play. Any investment in systems will have dual value, helping to manage energy load in response both to wholesale market signals and to distribution or transmission constraints. If there are regulatory barriers to distributors being more involved in managing load in ways that bring lower electricity costs to consumers and make more efficient use of resources, I would be interested to hear about them.

I would now like to turn to the issue of industry governance. We are nearing the birth of a new governance structure for the sector. At the end of September the Commerce Commission announced that it has authorised the proposed new rulebook for self-governance of the electricity industry, subject to four conditions.

This is a real milestone in what has turned out to be an arduous and lengthy process. The Commerce Commission has decided that on balance an industry governance board will be of greater net benefit than one imposed by the government. That will be true as long as the conditions imposed by the Commission relating to consumer interests and competition are met.

I expect the industry will closely scrutinise the Commerce Commission’s findings. So will I. However my current thinking is that the time has now come for the Electricity Governance Board to be put in place. I urge the sector to make this happen as quickly as possible.

As I never tire of pointing out, the alternative – or the penalty for failure to deliver on the Government’s policy objectives – is a government-appointed board and government regulation rather than self-regulation. That will happen if necessary, but I would much rather see the industry and its stakeholders sign up to the new rules and seize the opportunity to take responsibility for its own future.

I want to take this opportunity to thank all the network companies for their work so far in getting to where we are. I am aware that the contribution to ongoing development of this rulebook is immense and there is a lot still to be done.

Now that the Commerce Commission has given its authorisation, support for the new arrangements must be tested in a referendum, which must be won by a ‘substantial majority’. In my view a ‘substantial majority’ can only be achieved if there is broad support from all groups of voters. People need time to come to their views and to examine the Commission’s reasons when they are released. I will simply say now that you will need to have a good reason if you decide at this stage not to proceed.

There are of course other current issues of interest to lines businesses, some of them major.

The Commerce Commission has been making progress on its analysis of lines asset valuation methodologies and the proposed thresholds and control regime for lines businesses.

I am sure you will be taking the opportunity to make your views known in response to the discussion paper on valuation methods released by the Commission at the beginning of this month.

The Commission has also considered feedback on the earlier discussion paper on the thresholds and control regime and as a result has undertaken to consult further on this issue.

Before the end of this year, I understand the Commission intends to release a paper outlining its final decision on the form of thresholds, with the aim of making its first assessment of lines businesses’ performance against the thresholds by 31 March 2003.

Its earlier work, of effectively running the updated ODV handbook over lines companies, showed very high compliance and therefore only modest adjustments in valuation.

The issue of low fixed charges also remains with us. I thank the overwhelming majority of network companies that have complied with the Government’s expectations. Unfortunately there remain a couple of networks companies and some retailers that are not yet compliant and my patience has run out.

I have instructed officials to prepare regulations to ensure full compliance with the Government Policy Statement on low fixed charges. As you know, that requires all retailers to offer a low fixed charge tariff option to domestic consumers, meaning a fixed charge less than or equal to 10 percent of the bill of the average domestic consumer. For domestic consumers that means less than about 30 cents per day. The regulations will apply to named companies that are non-compliant.

I understand your Association is going to undertake work on developing model approaches to distribution pricing. Thank you for this. The Government Policy Statement requires the EGB to develop these model approaches, but it is important that work progresses on this issue.

There have been too many delays for my liking. The Electricity Governance Establishment Project has been the lead agency on this issue up until now, but they have made frustratingly little progress, so I am pleased that your Association has stepped in.

Let me tell you why I think this is an important issue. Firstly, one of the barriers to retailers competing nationally is that they have to manage a large number of different pricing arrangements. And I don’t mean different prices – I mean different pricing methodologies and terms and conditions generally. This creates costs for retailers in setting their own prices.

Model approaches to pricing, and a commitment by distributors to adopt these model approaches over time, will improve standardisation across the country and reduce the costs of retailers competing across different networks. This can only be good for competition and your consumers.

At the same time, however, standardisation should not be taken to the point where valuable price signals for distribution or generation investment are lost. I would not want to see distribution pricing averaged to the extent that we lose the innovative tariffs that lines companies are increasingly using to deal with congestion, for example.

There are also advantages in standardising the approach to charging embedded generators. Embedded generation, particularly renewables, will play a vital role in New Zealand’s sustainable energy future. One of the Government's goals is to facilitate the use of new electricity technologies, renewables, and distributed generation. We want to ensure there are no barriers to their use. If pricing methodologies are unduly harsh on embedded generation it won’t be built.

There are difficult trade-offs to be made in designing model approaches to distribution pricing, but this Government has a clear policy that embedded generation — particularly renewables — should not face barriers. That policy will need to be recognised in the model approaches to distribution pricing.

A third benefit from model approaches to pricing is that it will provide an accepted industry standard. I am sure you will see the benefit in being able to deflect some of the inevitable criticism that can arise from particular groups of consumers who feel they are being treated unfairly.

It is essential that you consult widely on this matter and involve all interested parties. The model approaches will eventually be picked up by the Electricity Governance Board. The board will not be able to use material that has been developed in a back room. The process must be open and consultative.

Many of you will be aware a proposed new Supplementary Government Policy Statement on Financial Transmission Rights has recently been consulted on. The most recent version was circulated on 9 September and submissions are currently being considered.

I want to thank you for your individual contributions and also for the work your Association has been doing representing the collective interests of distributors. You may have seen that the latest draft has taken a number of the concerns raised by distributors on board.

Financial Transmission Rights are complicated and contentious, and I would not wish to get into a technical discussion with you on their ins and outs. What I do know however, is that they will play a key role in facilitating retail competition, particularly in areas subject to transmission constraints, and in facilitating investment in upgrading the transmission grid. These are critical objectives.

I hope that once the policy statement is finalised, I will see distributors making a positive contribution to the work of the FTR group.

The Electricity Complaints Commission is up and running, and from all accounts doing an excellent job. It is one of the real success stories arising out of the Government Policy Statement.

But I am concerned that there are still a few network companies that have not yet joined the scheme. That is unacceptable to me. I am committed to membership of the scheme by all electricity companies. It would be a pity if the industry scheme was jeopardised by those electricity companies who haven’t joined up.

Those that haven’t joined must think carefully about their reasons and to take matters of concern to the Commission to see if they can be addressed. Those of you who are members have an important role to play in persuading your colleagues to join, unless you want to see the scheme jeopardised.

Before I finish I must make a brief comment on the issue of trees regulations. Discussions on this issue have been in progress ever since I became Minister of Energy, and long before that as well. I have instructed officials to draft papers for Cabinet consideration on this issue and I expect progress to be made on appropriate regulations before the end of this year.

I want to finish by reminding you all that the Government is completely committed to the Government Policy Statement and the objective of an efficient, fair, reliable and environmentally sustainable electricity sector. The recent McClinchy report shows that New Zealand lines companies are more reliable than Canada and Australia and not far behind the UK. Indeed progress on a number of areas has been pleasing, while in others the necessary work is still ahead of us all. I look forward to your positive contribution to ensuring the future of the electricity industry is strong and successful.

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