Politics - Shedding Light on the Rising Cost of Power (2 November 2009)

The fact that one man with a forklift was able to take out the power supply to the top half of the North Island shows how fragile New Zealand’s electricity network really is. Friday’s accident, in which a container hit a high-voltage power line in Otahuhu, caused extensive disruptions as some 280,000 homes and businesses lost power for several hours.

This, of course, is not the first time an accident has caused major blackouts in the country’s busiest city. In June 2006 a snapped transmission cable at the Otahuhu substation cut power to over half of Auckland, and in 1998, a major failure in the 40-year old power supply cables cut electricity to downtown Auckland for over a month.  

In response to this latest incident, Transpower, the State Owned Enterprise that owns and operates New Zealand’s national grid, explained that the accident had happened while the reserve circuit was out of action due to maintenance. Had it been operational, the blackout would not have occurred. A $540 million parallel cable that will take the risk out of the supply system is being installed but will not be completed until 2013.

Friday’s occurrence has once more focused public attention on our electricity system. The security of supply, as well as the rising cost of power, are key concerns of New Zealanders.

New Zealand’s electricity network consists of more than 11,000 kilometres of high voltage transmission lines, over 41,000 poles and towers, some 170 substations, and more than 1100 transformers. This network of high voltage transmission lines connects the generators that produce electricity with substations in towns and cities across the country. From there power is conveyed to end users by 24 lines companies and 13 retail companies.

There are six main generators. SOE’s Meridian Energy with around 28 percent of New Zealand’s total generating capacity mainly from hydro and wind, Genesis Energy with 22 percent from hydro and thermal plants, Mighty River Power with 16 percent mainly from hydro, geothermal and thermal, and listed companies Contact Energy with 21 percent and Trustpower with around 6 percent. Other generators, including small scale operators which produce Distributed Generation for their own use with their surplus capacity sold into the national grid, make up the remaining 7 or so percent of generation capacity.

New Zealand has a heavy reliance on renewable energy, with around 56 percent of our electricity supplies coming from hydro dams, 22 percent from gas fired power stations, 11 percent from coal fired power stations, 8 percent from geothermal stations, 2 percent from wind, and the balance from wood, biogas and oil. Around 44 percent of all power generated in New Zealand - some 40,000 GWh - is used by the industrial sector, 24 percent by the commercial sector and the remaining 32 percent is used by residential consumers. The annual growth in demand of electricity is relatively steady at around 700 GWh per year.

Back in April, in response to public concerns, the government appointed an Electricity Technical Advisory Group to review the electricity sector. They released their preliminary report in August.[1] A particular consideration was the affordability of electricity, since over recent years the price of power has risen substantially. Back in 1999, the average line charge for householders was 6.65 c/kWh and the average retail price 13.96 c/kWh. Today the average line charge is 34 percent higher at 8.93 c/kWh, while the average retail price has increased 69 percent to 23.62 c/kWh.[2]

This continual increase in the price of power is putting considerable pressure on household budgets - especially for families living in areas where their local authorities have banned wood burning for heating purposes. This has literally forced many residents into a far greater reliance on electricity than they would normally have chosen, through having to install heat pumps and other forms of electric heating.

In their report the Advisory Group identified factors that they considered were responsible for putting upward pressure on power prices. One of the main causes was the Resource Management Act, which they claim is a major cause of cost delays and price increases for new generation projects. It is worth noting here that in some countries, many of the seemingly insurmountable visual impact problems associated with hydro-generation projects have been overcome through the use of fully submerged turbines. A case in point is a small hydro scheme located in the town centre of Heidelberg in Germany on the River Neckar.[3] The power plant, which is completely invisible, generates useful renewable energy for the city.

In considering ways to reduce power price increases, the Advisory Group has recommended introducing greater competition between generators in order to drive down wholesale electricity prices, allowing lines companies back into retailing in order to encourage greater competition in the retail market, and encouraging greater energy efficiency.

Power industry consultant Bryan Leyland made a submission to the electricity review. In his submission, among other matters, he raised the fact that New Zealand’s once world-leading ripple control system has been allowed to run down. At one time, ripple relays were installed in every household to control water heaters. As a result, massive power savings were able to be made across the country during periods of peak demand.

In his submission Bryan also mentioned that significant shortfalls in the electricity market have resulted from the use of the “Vickrey Auction” system. A form of Vickrey Auction was used by the Government during the nineties for the sale of radio spectrum licenses. It caused significant embarrassment at the time. Under the ‘second price sealed-bid’ system used, in which the winner of a radio spectrum auction paid not the winning bid but the price offered by the second-highest bidder, the results were extremely unpredictable: “In one extreme case a firm that bid NZ$100,000 paid the second-highest bid of only NZ$6. In another the high bid was NZ$7 million and the second bid was NZ$5,000”.[3] In this often-quoted instance, instead of the two winning bidders paying a total value of $7,100,000, which was their combined bid for the spectrum,  the government received only $5,006, which was the total value of the second highest bids.

In light of growing concerns over the increasing price of power, I have asked Bryan Leyland, this week’s NZCPR Guest Commentator, to explain why he believes electricity prices in New Zealand are so high. He suggests that it is the structure of the electricity market itself that is to blame:

“New Zealand was one of the first countries to adopt an electricity market. The Wholesale Electricity Market Development Group (WEMDG) were given the job of designing  "a wholesale electricity market that …. would ensure that wholesale electricity is delivered at the lowest cost to the economy". In the end, it came down to two options. One option was what it is called a "single buyer" market the other, which they selected, was called a "Vickrey Auction" where each generator bids in at the lowest cost for which he is prepared to generate (or so the theory goes). The system operator determines the expected load, stacks up all the bids in price order and then pays all the generators at the price bid by the most expensive generator. In a power system that is almost entirely based on fossil fuel generation such as Australia's, this is a reasonably sensible system. Old, inefficient stations have to bid in at a high price while new efficient stations are able to bid at a lower price. So, in theory at least, new and efficient drives out old and inefficient.

“WEMDG was advised that there was little to choose between the two schemes (which seems very odd to me) but they were warned that the single buyer market carried no risks because it would clearly work and it would provide electricity at the average cost of generation. They were also advised that the Vickrey Auction based market was untested anywhere in the world and hence represented a voyage into unknown territory. For reasons that seem to be lost in the mists of time, the risky option was chosen”.

He concludes, “The major reason for our rapidly increasing electricity prices is that the hydro stations that generate more than 60% of electricity get rewarded with a very high price even though their real cost of generation is very low. To make sure that this does not show up as a very high rate of return on the original asset value, all the generators have revalued their hydro stations by a factor of three or more. They are then able to claim that their return on asset value is moderate - or even quite low!”

There is no doubt that many complex factors are responsible for the rising price of power in New Zealand. But while, on the one hand, the government has expressed their intention to reduce some of these cost pressures, on the other hand they are poised to increase the price of power through the introduction of an emissions trading scheme. Bryan Leyland has estimated that under such a scheme the cost of electricity to the consumer will increase by around $800 million a year - if CO2 is valued at $20 per tonne. That means that irrespective of what the government tells us, rising power prices will be a permanent feature of life in New Zealand – unless there is a huge public clamour against an ETS … and unfortunately, there is not much sign of that as yet!       

Read more from New Zealand Centre of Political Research.

FOOTNOTES:
All articles can be found on the NZCPR RESEARCH PAGE
1. MED, Quarterly Survey Energy Prices
2. Electricity Technical Advisory Group, Review of the Electricity Market
3. Renewable Energy Yearbook 1993, Heidelberg Hydropower Station
4. Paul Milgrom, Auctioning the Radio Spectrum

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