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OPTIONSCHOICESDECISIONS
UNDERSTANDING THE OPTIONS FOR MAKING DECISIONS
ABOUT NEW ZEALAND’S ELECTRICITY FUTURE
For further information contact: Paul Cruse Strategy Directorate Meridian Energy PO Box 10 840 WELLINGTON choices@meridianenergy.co.nz +64-4 381-1200 Disclaimer Meridian Energy developed the materials in this report for internal use and has sought to ensure the accuracy and validity of the facts, assumptions, models and analysis in the report as at the date of publica- tion. Some of those facts assumptions, models and analysis may not be correct. This report is intended as a starting point for informed debate and discussion of issues facing the wholesale electricity sector, and you must form your own view on the subject matter of this report. Meridian Energy will not be held responsible for any reliance on either the content of this report or on any errors or omissions it may contain, or for any changes in Meridian Energy’s views on these matters.
CHOICES
Foreword
Energy is essential to New Zealanders’ way of life. It is a critical factor for
maintaining and raising our standard of living and driving the country’s economic
growth. Electricity is a key form of energy. Last year, electricity represented around
30 percent of New Zealanders’ overall energy consumption. We take the supply
of electricity for granted until it is not there. However, it is undeniably central to
the functioning of our modern society.
Although there have been considerable improvements in the efficient We have endeavoured to provide an objective perspective on the issues
use of energy, our demand for electricity continues to grow. Year on facing the industry and possible futures for the New Zealand electricity
year, electricity consumption is increasing by around two percent. market. We have sourced our analysis of the wholesale electricity
This growth is being led by New Zealand’s expanding economy and sector from in-house expertise and experience and from a range of
growing population. The government’s economic growth objectives external sources.
mean that this demand growth should continue in the future. We have attempted to crystallise the key factors influencing the market
In recent years, New Zealand’s broader energy sector has been affected in the years ahead and particularly the uncertainties that will shape
by significant uncertainty. The world oil market has been buffeted the sector. We have sought to identify the actions that can be followed
by geopolitical instability, climatic events and large increases in to resolve these unknowns.
demand. New Zealand has been directly affected, given our reliance I encourage other industry participants to contribute with their own
on international oil markets. Closer to home, the reduction in Maui analysis and data so that the issues shaping the sector are better
gas reserves, coupled with uncertainty regarding future gas supplies, debated and understood.
has resulted in sharp increases in the price of gas. This gas market
I hope that this report will form a valuable input into everyone’s
shock has affected New Zealand’s wholesale electricity sector, given
understanding of the issues facing New Zealand’s wholesale
the growth of gas-fired electricity generation over the last five years.
electricity sector.
Regulatory changes in the electricity sector have added to the
uncertainty.
This report is Meridian Energy’s contribution to providing quality
information needed for making good decisions.
Government and its policy advisors require accurate information so
that they can make informed policy decisions. Regulatory bodies and
advisors need a thorough understanding of issues in the sector in order
to develop appropriate regulatory structures. Industry participants Keith Turner
require quality information to base generation investment decisions Chief Executive
on, so that industry costs are minimised and electricity security of Meridian Energy
supply is ensured. And, electricity consumers need to understand the
various issues in the industry so they are able to make well-informed
consumer choices.
CHOICES
Table of Contents
Part A
7 What are the Generation Opportunities
1 Strategic Overview Introduction 4
for Meeting Demand? 12
2 Electricity is Essential to our Modern Economy 5
7.1 Determining the Mix of New Generation 12
3 The New Zealand Electricity Industry – Background 5
7.2 Economics of New Generation 12
4 Electricity Demand Growth in New Zealand 6
7.3 Implications of Project Economics on the
4.1 Electricity Demand Growth to Date 6 Future Generation Mix 14
4.2 Historic Response to Meeting Demand Growth 6 7.4 Other Factors Affecting New Generation Options 16
4.3 Recent Response to Meeting Demand Growth 6 7.5 Summary 16
4.4 Future Electricity Demand Growth 7
4.5 Generation Options Currently Under Investigation 9
5 A Framework for Electricity Decisions 9
5.1 The Economics of Investment Decisions 9
5.2 Good Decision Making Requires Good Information 10
5.3 Future Uncertainties that Affect Investment Decisions 10
6 What is the Demand Side Potential
for Meeting Future Demand? 11
page 2
Part B
13 Wind 49
8 Review of Options 19
13.1 Introduction 49
9 Hydro Power 21
9.1 Introduction 21 13.2 The Role of Wind Generation 49
9.2 The Role of Hydroelectric Generation 21 13.3 Issues 50
9.3 Issues 22 13.4 Economics 52
9.4 Economics 23 14 Other Technologies 57
14.1 Marine 57
10 Gas 27
10.1 Introduction 27 14.2 Biomass 58
10.2 Gas Availability 27 14.3 Cogeneration / Combined Heat and Power 59
10.3 Combined Cycle Gas Turbines 30 14.4 Nuclear 59
10.4 Issues 30 15 Demand Side Management Initiatives 63
15.1 Introduction 63
10.5 Economics 31
15.2 High-level Review of Demand
11 Coal Generation 35
Side Management Initiatives 64
11.1 Introduction 35
15.3 Summary 66
11.2 The Role of Coal Generation 35
Appendix
11.3 Issues 35
Economics of the New Zealand
11.4 Economics 36 Wholesale Electricity Market 68
Bibliography 70
12 Geothermal 41
Glossary 72
12.1 Introduction 41
12.2 The Role of Geothermal Power Generation 42
12.3 Issues 42
12.4 Economics 44
page 3
CHOICES
1.0
Part A — Strategic Overview
Introduction
New Zealand’s demand for electricity is expected to
continue to grow strongly over the next 20 years. Demand
side initiatives will meet or reduce some of this demand.
A range of new generation investment will also be required.
This section of “Choices” examines the strategic meeting New Zealand’s future electricity
issues facing New Zealand’s wholesale needs, but they are only part of the
electricity sector. solution given the likely size of future
We begin by briefly reviewing the changes in electricity demand.
New Zealand’s electricity industry over the last 2. New large scale electricity generation
20 years. This is followed by an analysis of the projects will be required to meet
likely growth in electricity demand over the New Zealand’s future energy needs
next 20 years. and are likely to include a mix of
Two broad categories of response to this generation technologies including
demand growth are reviewed: renewables, gas and coal.
• Demand side initiatives. These are Further large-scale electricity generation
initiatives that influence the amount of projects will be required over the next
energy used by consumers. Our definition 20 years to meet New Zealand’s growing
of demand side initiatives includes energy needs. Some current generation
any opportunity to reduce demand at plant will also need to be replaced.
a distribution network level – either Economic project cost is a key factor in
by improving energy efficiency, using determining which projects get built. In
alternative energy sources or through general, the economic cost variation
distributed generation alternatives. between various projects of the same
• Supply side options. These are large-scale generation technology, whether a coal,
generation project options. Our analysis gas or renewable generation project, is
focuses on the economic cost of various greater than the cost variation between
generation forms and how New Zealand’s technologies. From an economic
generation mix may alter in the future perspective, this implies that
under various scenarios. New Zealand’s future electricity
Our key findings follow: production is likely to come from a
range of generation plant.
1. Demand side options can help address
some, but not all, of New Zealand’s 3. If significant volumes of low-cost gas
future electricity needs. are discovered in New Zealand there is
likely to be more gas-fired plant in the
Some demand side options, in particular future. However, this is unlikely in the
electricity efficiency initiatives, are an short to medium term.
economic and environmentally
sustainable approach to meeting The future share of each generation type
New Zealand’s demand for electricity. will depend on a number of factors,
some of which are currently unknowable.
These will form part of the solution to
page 4
PART A — STRATEGIC OVERVIEW INTRODUCTION
The biggest uncertainty is gas availability may be required for these projects to be owned and operated the local lines
and price. A future scenario where viable economically, particularly if large networks, and small amounts of
significant amounts of low-cost indigenous amounts of low cost gas are found. For generation and electricity retail functions.
gas are found, for example, another Maui instance, a policy environment where the In 1998, these companies were required
sized field is discovered, has significant cost of carbon is properly reflected is an to split out their retail businesses.
implications for the industry. Under this important avenue for supporting these In the nineties, ECNZ was split into
scenario it is likely there will be a greater projects. Contact Energy (1996) and then
proportion of new generation that is gas- in 1999, into Meridian Energy, Genesis
fired with some renewable generation. 2 Electricity is Essential to
Energy and Mighty River Power. Contact
However, this outcome is unlikely in the our Modern Economy Energy was privatised in the same year.
short to medium term. The electricity system, from generation to The other three companies remain
4. In the absence of a major gas local distribution, is infrastructure critical SOEs today.
discovery renewable generation is to the New Zealand economy. Over more A key outcome of the restructuring
likely to fill a larger part of total new than a hundred years, electricity has process was the separation of the natural
generation capacity. shaped how New Zealanders live and monopoly elements of transmission and
work. Electricity has become so central to distribution from the contestable
Renewable generation is likely to fill a
modern life that there are often no elements of electricity generation and
larger part of total new generation
substitutes. retailing. The formation of several
capacity if a large, low cost gas discovery
Reliable and cost effective access to electricity generation companies enabled
is not made. Under these scenarios, the
electricity is fundamental to the ongoing the development of a competitive
best new generation projects will be wind
progress of New Zealand. It is a key wholesale electricity market.
farms in prime locations, hydro generation
in prime locations and geothermal element in delivering New Zealanders’ Regulatory processes have also
expansion projects. These projects have standard of living. Electricity is an developed in parallel with these
the advantage of being environmentally essential ingredient for all parts of the structural changes. Industry self-
sustainable. However, there are only a economy and society. governance processes were successfully
limited number of prime, “consentable”1 The future electricity outlook is established for the wholesale electricity
renewable projects available. determined by growth in demand and market, which began operation in 1996.
supply, and the design of the policy and After several years of operation,
5. Project economics are an important it became apparent that an overarching
regulatory framework. It is these topics
factor driving the mix of generation regulatory framework was required to
we turn to next.
projects. However, there are other monitor the market and to enable
considerations that determine the 3 The New Zealand Electricity transmission investment decisions.
selection of projects. Industry – Background Attempts by the industry to develop a
Although the cost of various generation self-regulatory framework failed and the
Over the past 20 years, New Zealand’s
project options is a key factor in government acted to establish the
electricity industry has undergone
determining project selection there are Electricity Commission, an industry-
substantial structural change. In the mid
also other important considerations. specific regulator, in 2003. The
eighties, the Ministry of Energy
For instance, the ability of a generation Commission is responsible for overseeing
was restructured, with the generation
company to gain access to land and to transmission activities, administering the
and transmission assets of the Ministry
obtain appropriate resource consents is operation and development of the
being transferred to the Electricity
another key factor that affects the wholesale electricity market and
Corporation of New Zealand (ECNZ).
viability of a project. ensuring electricity security of supply.
ECNZ was set up as a company under
the State-Owned Enterprises (SOE) Act The main players within the current
6. Not all renewable projects are created
1986. Transpower was subsequently industry delivery chain include:
equal; there are a limited number of
“prime” projects. Projects that are split out of ECNZ as a separate SOE to • Electricity generation companies.
defined as “good” may require some form perform the functions of transmission There are six major generation
of incentive or favourable regulatory asset owner and system operator. ECNZ organisations. Three of these companies
environment to get across the line. became the owner and operator of all are SOEs: Genesis Energy, Meridian
large-scale generation facilities. Energy and Mighty River Power. Contact
There are only a small number of wind, Energy, TrustPower and Todd Energy are
Over the same time period, local
hydro and geothermal projects that fit into privately owned.
Electricity Supply Authorities (ESAs)
the “prime” category. Many are defined as
were corporatised. Prior to this ESAs
projects in “good” locations. Incentives
1
We use this term to describe the ability of a project to obtain an appropriate Resouce Consent.
page 5
• Transpower, an SOE transmission Economists refer to this as “demand especially during dry years.
owner and system operator. inelasticity”. There are three main The strong base of hydro generation
• Electricity lines companies. These reasons for this: has been supplemented by geothermal
organisations provide local distribution • Price has been historically low by world and more flexible ”hydro-firming”
services between Transpower and standards. Until the last few years, thermal generation from Meremere,
consumers. Vector is the largest lines changes in price have been modest. Marsden A (both now decommissioned),
company in New Zealand. • Residential consumers are on fixed-price New Plymouth, Huntly and more
• Electricity retailers. These companies contracts; these are usually reviewed recently combined cycle gas turbine
have the supply relationship with most annually. This lack of price information stations in Auckland and Taranaki.
electricity consumers. Currently, most of limits demand responses. Thermal generation has provided the
New Zealand’s retail activities are owned New Zealand power system with the
• There are no energy substitutes in many
by the six largest generation companies. flexibility required to provide the
applications.
ongoing balancing of supply and
• Major industrial organisations and However, wholesale electricity prices demand across a broad range of
end consumers. have increased significantly over the last hydrological sequences. In the past,
Apart from the Electricity Commission, few years. There are two main reasons these sequences have varied as much as
the Commerce Commission currently for this. First, the gas contracted under 25 percent above or below average.
manages information disclosure and the Maui Gas Contract is running out.
4.3 Recent Response to Meeting
price setting regulations over all lines The period of low gas prices driven by
this contract is ending and gas-fired Demand Growth
companies, including Transpower.
The Commerce Commission also sets generation is using gas supplied at Recently there has been debate over the
quality thresholds. a higher market price. Secondly, effectiveness of the wholesale electricity
New Zealand’s cheapest generation market to deliver timely investment.
4 Electricity Demand Growth options have been exercised. New While this debate is likely to continue,
in New Zealand generation plant will inevitably be the fact is that significant generation
more costly. capacity has been added to the system
4.1 Electricity Demand Growth to Date since the market began operation in
Information presented later on the cost
New Zealand‘s demand for electricity of new generation shows that there will 1996. Figure 2 sets out annual and
has grown consistently over the last continue to be upward pressure on the cumulative new generation capacity
20 years. Electricity consumption has wholesale electricity price in the medium (including decommissioned generation
increased from approximately 27.7 TWh term, unless a significant, low-cost capacity) versus new cumulative demand
in 1985 to 41.5 TWh in 2005, indigenous gas discovery is made. growth since 1996.
an average growth rate of 2.2 percent This graph shows that the wholesale
As the wholesale electricity price
per annum. market has operated so that additional
increases, we expect it to have a
Over the last 20 years, the growth in greater impact on electricity demand. capacity has been commissioned in
electricity consumption has been driven Amongst other things, higher prices response to demand growth. Generation
primarily by a combination of two factors: should encourage improvements in in the first few years was already
• Population growth. energy efficiency. committed prior to the establishment of
the market. However, the market has
• Economic growth measured by Gross 4.2 Historic Response to Meeting
operated since this time to ensure
Domestic Product (GDP). Electricity is Demand Growth electricity security of supply through the
an important factor of production in
Historically, electricity demand growth provision of additional capacity.
energy-intensive industries such as dairy
has been met from a diverse range of As expected, the margin between
farming, forestry, metal smelting and
fuel sources with a heavy emphasis on additional capacity and additional
agricultural-based products. In addition,
renewables – particularly hydro energy. demand tightened in the early 2000s
income is an important driver of
Around 60 percent of New Zealand’s in response to a period of capacity
electricity demand; GDP is one measure
electricity is produced from renewable over-supply. However, the projected
of income.
resources. This result is a positive margin of capacity over demand in
The relationship between electricity outcome from an environmental 2007 is expected to be similar to
demand and GDP is shown in Figure 1. sustainability and climate change the margin experienced in the late
Overseas, electricity price is also an perspective. However, from time to time 1990s. This fluctuation is a natural
important factor affecting electricity it has led to New Zealand being consequence of the lumpy nature of
demand. To date, price has not had a susceptible to climate-related risk, new generation plant.
significant impact in New Zealand.
page 6
FIG 1: NEW ZEALAND ELECTRICITY DEMAND AND REAL GDP, 1946-2005
40,000 140,000
35,000 120,000
Total Industrial and
Commercial Demand
Annual Demand for Electricity (GWh)
30,000 Residential Demand
100,000
Real GDP $95/96
25,000
GDP ($M 95/96)
80,000
20,000
60,000
15,000
40,000
10,000
5,000 20,000
– –
1984
1964
1946
1948
1972
1978
1950
1952
1956
1958
1960
1962
1966
1968
1980
1982
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
1954
1970
1976
1974
Year Ending March
FIG 2: NEW GENERATION CAPACITY AND DEMAND GROWTH, 1996-2007
15,000 15,000
Committed Gen.
Incremental Generation & Demand (total cumulative GWh)
Cumulative Gen. Growth
13,000 13,000
Gen Decommissioned p.a.
Annuual Generation & Demand (GWh per annum)
Gen Commissioned p.a.
Avg Demand p.a.
11,000 11,000
Cumulative Demand Growth
Forecast Demand
9,000 9,000
7,000 7,000
5,000 5,000
3,000 3,000
1,000 1,000
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
-1,000 -1,000
Commission Date
Other related observations on the 4.4 Future Electricity Demand Growth However, it is likely there will be some
market include: We expect that electricity demand will “decoupling” of GDP and electricity
• new generation capacity has exceeded continue to grow in response to GDP growth over time as:
demand growth since 1996 growth and population increases. The • the New Zealand economy matures and
• generation has been developed utilising government’s broad economic objective there is an increased focus on value-
a range of technologies and “fuelled” by is to return New Zealand’s per capita added products
a range of energy sources including gas, income to the top half of the OECD. This • electricity prices rise
wind, hydro and geothermal objective will require New Zealand’s
• there is an increased focus on energy
economic growth rate to be consistently
• generation investments have been efficiency.
above the OECD average growth rate for
implemented by all of the five major
a number of years.
generators.
page 7
FIG 3: ELECTRICITY DEMAND AND GENERATION PRODUCTION. 1969-2028
65,000 65,000
Oil Peaking
60,000 60,000
55,000 55,000
New Plymouth
50,000 50,000 CCGTs
45,000 45,000
Huntly
Annual Generation (GWh)
40,000 40,000
Meremere
35,000 35,000
30,000 30,000
Other Gen.
25,000 25,000 SI Hydro Total
20,000 20,000
NI Hydro Total
15,000 15,000
Total Geothermal
10,000 10,000
Forecast: 1.2%-1.9% pa
5,000 5,000
– – MED History: 3.3% pa
2011
2001
2003
2005
2007
2009
2013
2015
2017
2019
2021
2023
2025
2027
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
Year Beginning April
TABLE 1: POTENTIAL NEW GENERATION OPTION
Wind Geothermal Hydro Other
Gumfields Ngawha extension Mohaka e3p
Pouto Kawerau Toronui Mini Hydro Rodney PS
Te Uku Rotokawa extension Mokau Rodney PS Stage 2
Taharoa Mangakino Kaituna Marsden B
Taumatatotara McLachlan PS North Bank Tunnel Southdown Extension
Mokairau Te Mihi Drilling Hawea Gates Atiamuri Landfill
Titiokura (Unison) Ohaaki Drilling Lake Rochfort Horotiu Landfill
Te Waka South Tauhara Gowan Whareroa Cogen.
Titiokura (HBWF) Mokihinui Greymouth 4xGT
Tararua 3 (T3) Coleridge Upgrade Buller Coal
Te Rere Hau Stage 1 Wairau Burwood Landfill
Te Rere Hau Stage 2 Dobson Nelson Landfill
Turitea Waipori Deep Stream Otahuhu C
Motorimu Rangitata Diversion
West Wind Manapouri Refurbishment
Puketiro
Stoney Creek
Hayes
Lake Mahinerangi
Rock & Pillar
Cairnmuir Hill
White Hill
9,935 2,475 3,360 12,130
Total GWh p.a. 27,900
page 8The key area of uncertainty regarding Many of these projects are unlikely to Because of the critical role that electricity
demand growth is the rate of growth proceed, at least in the short to medium plays in society, governments typically
and how specific regions will vary in term. However, the total potential have other, broader, policy objectives for
response to local economic conditions. electricity production of this list is far the sector such as particular social
At a national level, our view is that greater than likely growth in demand of outcomes. For instance, the New Zealand
electricity demand growth will continue around 500-900 GWh p.a. government has social equity objectives
to be significant. The rate of growth will The volume of new generation projects such as the availability of electricity to
require new base load generation to be publicly known to be under investigation all classes of consumer and fairness
installed in the order of 500-900 GWh suggests a number of points: considerations.
per annum. These broad objectives are espoused
• committed projects should meet demand
We expect electricity demand in 2030 growth until 2009 in a number of government policy
to lie somewhere between 55,000 documents, including the government’s
• market signals to investigate and build
and 65,000 GWh. This equates to Sustainable Development: Programme
new generation are being acted upon
an increase of 30-60 percent in of Action and its Government Policy
– in all parts of the country, from diverse
generation capacity. Statement on Electricity Governance.
sources of generation, and from multiple
Figure 3 illustrates New Zealand’s companies The framework for meeting these
historical generation output across all objectives is discussed in the following
• although it is uncertain which of the
major sources against demand growth. sections.
projects listed in Table 1 will proceed,
The demand growth is forecast from 5.1 The Economics of Investment
appropriate levels of electricity security
2006 as a potential range. Even with
of supply are likely to continue well into Decisions
the most conservative demand growth
the next decade Under the wholesale electricity market
assumptions, which include a high
degree of demand side initiatives such It would appear that New Zealand structure, market signals should lead to
as energy efficiency programmes (see should be well served in terms of: efficient investment in new generation
section 6), there is a significant gap • available and diverse generation options plant or demand side initiatives,
between supply and demand. The need including energy efficiency. The market
• a wide range of companies willing to
for additional generation capacity is provides signals for generation plant
commit significant resources in the
clear. investment or additional demand side
electricity industry.
initiatives as the underlying demand
4.5 Generation Options Currently for electricity grows.
5 A Framework for
Under Investigation
Electricity Decisions The mechanism for this investment
A range of new generation proposals signal is discussed fully in the appendix
have been put forward by both It is generally acknowledged that an “Economics of the New Zealand
established participants and new electricity system should be managed in Wholesale Electricity Market”.
entrants to the industry as market a manner that encourages efficient Generation or demand side decisions
conditions have tightened. These production and energy use. The system are based on the marginal cost of
proposals are at various stages, from should provide a security of supply various options; the marginal cost is
initial pre-feasibility proposals through to outcome that is consistent with the cost of producing an incremental
committed projects. consumers’ willingness to pay. These unit of output.
There have been public announcements economic objectives are necessary for a
relating to 22 wind farm proposals at well-functioning electricity sector.
different stages of evaluation, planning An electricity system should also be
or construction. There are also 15 hydro, managed to meet the government’s
8 geothermal and 13 natural gas, coal, environmental sustainability objectives.
cogeneration or landfill gas options at In New Zealand, this outcome is
various stages. These projects have a delivered through the Resource
combined production of around Management Act. It is also realised
27,900 GWh. These projects are listed in through other frameworks such as the
Table 1. Projects highlighted in red are Crown’s climate change policy.
committed. In addition to these projects,
there are others that are not in the
public arena.
page 9that prices the externality of carbon making by the industry requires
Short run marginal cost
emissions. Other environmental objectives uncertainty to be minimised. In recent
For current electricity supply the short are largely addressed through the times, New Zealand’s electricity industry
run marginal cost (SRMC) of plant application of the Resource Management environment has been affected by a
tends to drive the market price and Act. Social and other objectives may be range of uncertainties, that have
plant operation. This marginal cost threatened the viability of new
incorporated through appropriate
comprises fuel (including the option generation initiatives. These include
regulatory design – for example, the
value of fuel such as the value of uncertainty about gas availability and
requirement for retailers to provide low
water storage and coal stockpiles) regulatory settings.
fixed-charge user tariffs.
and other variable operating costs
5.2 Good Decision Making Requires Good Gas availability has been a major
– costs that can be avoided in the
Information uncertainty over the last several years
short term.
following the redetermination of Maui
Long run marginal cost In order for good outcomes to occur, a
gas reserves. As a result, Contact Energy
necessary requirement is that parties
For future supply, where further is reconsidering its development of
involved in decision making have access
generation investment or demand Otahuhu C, a proposed CCGT
to appropriate information and that
side options are necessary to meet (Combined Cycle Gas Turbine) plant
growth in demand, the long run uncertainty is minimised. These parties
with a generation capacity of up to 400
marginal cost (LRMC) is more include generators, the transmission
MW. Genesis Energy is proceeding with
relevant. The LRMC of a new power provider, policy makers, regulators and
e3p, another CCGT, but only on the back
station is the total marginal cost of consumers. There should be clear signals
of a government guarantee that shares
producing electricity from the plant. for investment and policy should be
this fuel availability risk.
It includes SRMC plus fixed costs, in made on a well-informed basis.
Little can be done to reduce this fuel
particular the capital investment cost These signals are important irrespective
uncertainty except by finding the gas or
of the station. In this report we have of the industry structure. For instance, in
proceeding with alternative generation
taken the LRMC of a plant to be the centrally planned era of the
options such as wind. For instance, the
equal to its (levelised) unit cost. Refer New Zealand Electricity Department,
government is attempting to stimulate
also to the glossary for a definition of understanding of the costs of various
further petroleum exploration through a
these terms. generation and transmission plant was
number of initiatives. As discussed
required so that planners could make earlier, a number of renewable
From an economics perspective, the next appropriate investment decisions. In the generation options are being developed.
initiative required to meet incremental current wholesale market structure, This form of risk is intrinsic to the energy
demand should be the lowest-cost information is required so that generation sector and industry participants are in
option from the portfolio of potential companies can make efficient, least cost the best position to deal with it.
generation and demand side projects investment decisions and so a robust
The other major uncertainty facing the
available. The relevant measure of cost is transmission network can be developed
industry is regulatory uncertainty. Since
long run marginal cost (LRMC). The in a way that delivers security of supply
the 1980s, the electricity sector has been
LRMCs of potential demand side and and facilitates competition.
the subject of extensive regulatory
generation initiatives are discussed in The difference in the two regimes reform. The latest major reform was the
the following sections. lies not in the information required, establishment of the Electricity
As New Zealand’s electricity demand but rather on how effectively this Commission in 2003. Particular issues
continues to grow, least-cost generation information is translated into rational affecting generation decisions include:
and demand side investment will be decision making. Economists argue
• Uncertainty over climate change policy.
critical to maintaining downward that centrally oriented structures tend
The government reversed its decision
pressure on prices. Consideration of the to lead to muted signals with inefficient
to introduce a carbon tax last year.
cost of various options is a key part of outcomes. In contrast, a well-designed
It is currently working on alternative
achieving the broader outcomes for the market structure should lead to
policy options. A decision to introduce
sector as detailed in various government more efficient outcomes, provided
a price on greenhouse gas emissions
policy documents. there is good information and
will fundamentally affect the economics
regulatory certainty.
These broader outcomes can be of various generation forms. Certainty
achieved by building on the LRMC 5.3 Future Uncertainties that Affect in this area is required for parties to
investment signal. For instance, the Investment Decisions commit to new generation projects.
government’s climate change policy may Electricity generation projects are capital • Transmission issues. A robust
be incorporated through a mechanism intensive and costly. High-quality decision transmission grid is fundamental to the
page 10FIG 4: HIGH-LEVEL DEMAND SIDE MANAGEMENT INITIATIVES LRMC COMPARISON
100 1,000
Variable Retail LRMC
80 800
LRMC (2006 $/MWh)
Wholesale LRMC
LRMC (2006 c/kWh)
60 600
40 400
20 200
– –
Compact Fluorescent Lights
Efficiency Initiatives*
Photo voltaic 5kW
Other Energy
Solar Hot Water
(New Build)
High Eff. Low Capital
Solar Hot Water
(New Build)
Low Eff. High Capital
Solar Hot Water
(Replacement)
High Eff. Low Capital
Solar Hot Water
(Replacement)
Low Eff. High Capital
Micro Wind 20 kW
Micro Wind 10 kW
Low Capital
Micro Wind 10 kW
High Capital
Micro Wind 1 kW
Low Capital
Micro Wind 1 kW
High Capital
* Note – other energy efficiency initiatives include household insulation and motor efficiency improvements.
Unit costs were sourced from the Electricity Commission’s pilot programme publications.
operation of the electricity sector. • General regulatory uncertainty. • small scale distributed generation
A variety of transmission issues are The industry has gone through a (DG) options including micro wind
uncertain, particularly given issues protracted period of change, including turbines and photovoltaic generation.
over the accountability and roles of major changes in the regulatory As with supply side initiatives, the
Transpower, the Electricity Commission environment. The introduction of an net economic benefits and market
and the Commerce Commission. industry regulator has been a useful step potential of DSM initiatives vary with
Certainty on these issues is required towards getting clarity on some issues. the specific application. There are a
for some new generation projects to However, the regulatory environment number of DSM initiatives that are
proceed. The government’s recent policy needs to be more stable with an economic when compared with the unit
statements are a good start in this emphasis on clear communication cost of electricity supply from large-scale
area, though further direction may between regulatory bodies and industry power plants. Some DSM options also
be required. participants and a focus on “no enable management of the daily
• Lack of consistency in RMA issues across surprises”. electricity demand profile.
local body areas. Decision making on
In general terms, energy efficiency
the management of resources is 6 What is the Demand
measures provide the highest degree of
devolved to territorial and regional Side Management Potential national benefit as many projects can
authorities. The rationale for this for Meeting Future Demand? be delivered below the unit cost of
approach is that these authorities
supply. Micro-generation is viable in
are better placed to make decisions There are clear opportunities for
isolated cases, although it is heavily
about the use and development of demand side management (DSM)
dependent upon site resources and
local natural resources. However, these initiatives to form part of New Zealand’s
overcoming resource consent barriers.
authorities take different approaches energy future.
Figure 4 summarises the high-level unit
to various issues. There also tends Our definition of DSM includes measures cost comparison of the demand side
to be a focus on local issues rather such as: management initiatives investigated
than the national interest, although
• energy efficiency initiatives (resulting in in this report.
national policy statements may be
demand reduction) Section 15 has more detailed
used to address this point. This lack of
consistency creates uncertainties for • the use of other energy sources such as information on the costs modelled
generation investors. solar hot water heating in this graph.
page 11There are several DSM options that • How does climate change policy inherent in each form. As discussed, the
appear to be viable options when affect the economics of individual most obvious example of such a risk is
compared with current retail tariffs. projects? Climate change objectives hydrology variability associated with
However, these tariffs include variable may be incorporated through some hydro generation. Thermal generation
price components that are actually form of carbon price or appropriate can mitigate at least some of the risk of
related to fixed transmission and regulatory regime. uncertain hydrology by operating harder
distribution costs. If there is significant • Given these considerations, what when water inflows are low and easing
uptake of DSM options, these tariffs forms of generation make the best off when they are high.
would need to be rebalanced so that economic return? Over the next 20 years, new renewable
network costs were recouped. In this Other broader objectives, such as social generation projects will be dominated by
situation, a smaller proportion of the policy outcomes, may influence forms currently under consideration: wind,
retail tariff would be avoided by generation investment decisions through hydro and geothermal. Other emerging
investing in DSM options. Accordingly, the regulatory environment. technologies are likely to take at least
comparison with the wholesale price is
In order to understand the economics 20 years to mature before they become
more relevant. There are fewer DSM
of new generation investment over the part of New Zealand’s electricity
options that are viable when measured
long term, it is important to first generation mix. Similarly, thermal options
against this yardstick.
understand the dynamics of various over this timeframe will be dominated by
Although there are some DSM options generation forms. As discussed, the current coal and gas technologies.
that appear economic, the effect on New Zealand electricity system has Renewables generation will play a key
demand is relatively modest. The gap some relatively unique characteristics. role in meeting New Zealand’s future
is illustrated in Figure 23 in section 15. In particular, the sector is dominated by electricity demand. However, the portfolio
The Electricity Commission has renewable generation, particularly hydro benefits of having a diverse mix of
provisionally estimated that DSM generation. This form of generation generation forms coupled with the
options are likely to contribute the utilises New Zealand’s abundant natural relative economics of various specific
equivalent of around 1,800 GWh by resources to deliver comparatively projects means that further thermal
2026 (Electricity Commission, 2006c). low-cost, low-carbon emission electricity. generation is likely. The proportions in the
The remaining energy balance “gap” Because it has high capital and low mix will depend on the relative economics
(estimated to be over 13,000 GWh in operating costs, it is ideally suited to
of the individual generation forms and
2026) will need to be met from medium- operating as baseload plant. However,
their ability to meet the wider policy
to large-scale power generation sources. at various times, the role of hydro
objectives for the industry. As discussed
generation may shift depending on
7 What are the Generation hydrology.
earlier, gas availability and price are
Opportunities for Meeting major uncertainties facing the industry
The rest of production is sourced from at the moment. How these uncertainties
Demand? thermal plant – mainly coal and gas-fired unfold will affect New Zealand’s
New generation plant will be required plant. This plant has lower capital costs electricity generation mix over the
to meet consumers’ growing demand for and higher operating costs. Recently, medium term. Other factors such as
electricity. Generation options that are as the gap between demand and the nature of the future regulatory
proposed in the short term were listed in generation capacity has shrunk, much environment and environmental issues
section 4. The factors that will affect the of New Zealand’s coal and gas plant has
will also influence this mix.
mix of generation in the longer term are operated as base-load plant. In addition,
this plant operates as base-load 7.2 Economics of New Generation
discussed below.
generation when hydrology conditions The range of viable generation options
7.1 Determining the Mix of
become tight. However, coal-fired plant will be limited by companies’ ability to
New Generation in particular is physically more suited to consent particular projects. Of the
The mix of investment in electricity being operated as a mid-merit or hydro- projects that can be consented, from an
generation plant is determined by firming plant. economic perspective the projects that
several factors. It is driven primarily by A mix of diverse generation forms is should proceed are those with the lowest
economic considerations: essential to the proper functioning of LRMC. We identified earlier the potential
• How do environmental factors affect the New Zealand electricity wholesale for other criteria also to affect final
the economics of particular projects? sector. The various forms of generation investment decisions. Even if there are
For instance, resource consent conditions have different attributes and perform such factors, project LRMC is a necessary
may alter the economics of a project complementary roles. A diverse range of starting point for considering other
or prevent it from proceeding. generation types helps to limit the risks objectives.
page 12FIG 5: HIGH-LEVEL GENERATION LRMC COMPARISON
Gas Coal Wind Hydro Geothermal
120
100
80
CO2 $25
60 CO2 $15
O&M
40
LRMC (2006 $/MWh)
Fuel
20
Capex
–
Geothermal Expansion
Patea Coal: 2x350MW
Marsden Coal: 320MW
New Geothermal: Binary
New Ply. Coal: 2x350MW
CCGT Gas@$7.0: 385MW
CCGT Gas@$4.5: 385MW
Hydro: Large (excl. HVDC)
Wind Good Tier 1:100MW
Wind Good Tier 2:300MW
New Geothermal: Standard
CCGT Gas@$10.5: 385MW
Hydro: Difficult (excl. HVDC)
Hydro: Medium (excl. HVDC)
Wind Average Tier 2:100MW
SI Lignite: 3x350MW (excl. HVDC)
This figure shows LRMC or unit cost estimates of various generic project types: respectively, gas (combined cycle gas turbines), coal (supercritical pulverised coal stations), wind, hydro and geothermal. The generic projects presented
illustrate how LRMC varies within and between each generation form.
The bottom part of each bar represents the fixed cost portion of LRMC (i.e. capital costs); the coloured parts above this represent the variable cost potion (i.e. fuel and operations and maintenance costs). The remaining transparent
portions on the gas, coal and geothermal bars identify the impact on LRMC of various carbon regime scenarios (specifically $15 and $25 /t CO2e carbon price scenarios as proxies for the impact of possible carbon policies).
These cost estimates are discussed in detail in Part B of this report.
The selected generic projects for each generation form show the variability between a “prime” project at one extreme (which has a lower LRMC) and an “average” project (which has a higher LRMC) at the other extreme. This vari-
ability is driven by location-specific issues for the various generation options and, in the case of thermal projects, fuel costs.
We have not included the impact of an HVDC charge in these LRMC estimates. Under the current transmission pricing methodology this charge adds up to $10/MWh to the LRMC of South Island renewable opportunities and up
to $5/MWh for a lignite coal-fired power station in the South Island.
page 13In the discussion that follows, we significantly by variable fuel costs. A new CCGT plant running on LNG gas
consider the LRMC of various generic In contrast, the costs of all the at delivered prices of $10-11/GJ is
generation projects to understand the renewables options are weighted much uneconomic, at least in the medium
possible mix of future electricity more towards fixed capital costs, term. Importation of LNG in this price
generation in New Zealand. typically 80-95 percent of LRMC. range only appears to be economic for
The estimated LRMC of various generic re-firing existing gas-fired plant where
3. The relative economics of various the capital cost is already sunk.
generation projects is summarised in
potential generation projects is
Figure 5. In this report we use the Coal
dependent on individual project
(levelised) unit cost of a project as the
characteristics and fuel costs. The economics of new coal generation
proxy for the project’s LRMC. A 9 percent
plant are much more site specific than
post-tax nominal discount rate has been The LRMCs of various generation forms
CCGT gas plant – even when running on
used. See the glossary for an explanation are driven by the characteristics of
imported coal. The key difference is the
of these terms. individual projects. Even within each
specific infrastructure that needs to be
generation technology, the LRMC range
7.3 Implications of Project Economics on developed to service particular coal plant
is relatively wide, reflecting the
the Future Generation Mix options. Section 11 discusses coal
characteristics of individual projects.
A number of conclusions follow from generation in detail.
Factors that affect each form of
Figure 5. generation are detailed below. The cheapest greenfields coal generation
option in New Zealand appears to be a
1. The LRMC spread within generation Gas
large Southland lignite plant located
forms is generally greater than the The economics of a combined cycle gas next to the lignite coal fields at
variation among most forms. turbine (CCGT) plant are primarily driven approximately $70/MWh, excluding the
For each type of generation, there are by the gas price as delivered to the cost of carbon. However, this would
a range of possible LRMCs depending on plant. Over time, this price will be set by require significant transmission upgrades
the characteristics of individual projects. the nature of future gas discoveries or to transport electricity to consumers.
There are favourable, or “prime”, projects the price of imported gas. Section 10 Other coal options are significantly more
with relatively low marginal costs at one discusses gas generation issues in detail. expensive than this. New North Island
end of the spectrum. At the other end, If a large gas discovery is made in a coal generation using imported coal is
there are projects with higher marginal location with supporting infrastructure, likely to sit somewhere between $85-
costs. The LRMCs of various generation for example on the west coast of the 100/MWh – mostly depending on the
technologies tend to overlap each other. North Island, the wholesale gas price proximity to an existing large port.
This overlap implies that there is the could be at the lower end of the scale – Coal is likely to be particularly affected
potential for a mix of new generation perhaps $4.50/GJ, depending on field by the introduction of a carbon regime.
forms in the future. The proportions of economics. At this price, gas-fired new In a scenario where there is a price on
the various generation technologies will generation would dominate most other carbon emissions most new coal-fired
depend on various factors. The factors generation options. New generation generation projects are uneconomic.
with the greatest influence include gas would tend to be gas-fired, though there
would be some renewable investment. Wind
availability and price. The nature of the
regulatory environment, including the There would be no new coal-fired The relative economics of specific wind
carbon regime, is another key factor. stations. A price on carbon or other farm projects are driven by the local
changes in regulatory settings alters this wind resource, the scale of the
2. The make-up of LRMC differs between development, complexity of the site and
conclusion. The implications of
thermal and renewable projects. introducing a carbon regime are supporting roading and transmission
The LRMC of thermal projects is discussed later. infrastructure. As such, the LRMC of
primarily driven by operating costs Alternatively, if current gas contract price wind projects are highly site specific.
– particularly the costs of fuel. This is expectations persist, at around $6-7/GJ, Section 13 discusses wind generation
especially true for gas-fired generation. then the CCGT LRMC would be issues in detail.
For example, the LRMC of new CCGT approximately $70/MWh, excluding A site with an excellent wind resource
plant is driven largely by the delivered any carbon price. A greater range of (above 10 m/s) could have an LRMC
gas price, with capital costs having a renewable projects is economic under between $60 and $70/MWh depending
much smaller contribution, around this scenario, as well as some coal on the above factors – however there
20-35 percent. New coal generation options. There would be a mix of new are only a handful of these sites
has a larger capital component, around generation forms. Again, a carbon nationwide with a potential of around
45-60 percent, but is still affected regime potentially alters this conclusion. 2,000 GWh.
page 14A site with a good wind resource and most successful type of geothermal Accordingly, transmission investment
(over 8 m/s), reasonable scale and a project. The Mokai extension project is should be considered as an enabler of
location situated close infrastructure an example of a brownfields expansion. least-cost electricity generation. Parties
could have an LRMC between $75 and These brownfields sites are possibly the developing the transmission investment
$85/MWh. There are likely to be a cheapest of all of the new generation process should consider how efficient
number of such sites throughout options with an LRMC estimated to be transmission investments can be
New Zealand, with combined potential around $50-70/MWh. However such implemented ahead of certainty over
of around 6,000 GWh. developments are limited largely to the generation developments.
Sites with an average wind resource that eight key existing geothermal generation 5. A carbon regime enables more
are distant from infrastructure or are fields – up to about 2,500 GWh renewables generation.
small scale could have an LRMC in potential. Section 12 discusses
excess of $90/MWh. These sites are Figure 5 shows the impact of pricing
geothermal generation issues in detail.
likely to be more plentiful. the carbon emissions created from
A new geothermal project on top of thermal generation, with the cost of
Apart from site characteristics, wind a good reliable resource could have an thermal generation plant increasing
farm economics are also affected by LRMC in the range of $75- 85/MWh against other options. The effect on
economic conditions at the time of depending on the technology selected. the LRMCs of thermal projects under
committal. Key factors include exchange Beyond this, if the geothermal resource is the two carbon scenarios analysed is
rates, steel prices and international either not ideal or deteriorates over time, summarised in Table 2.
turbine demand.
then the unit cost can climb rapidly. A carbon charge increases the cost of
Hydro thermal generation, with the size of the
4. A robust transmission grid is required
Similar to wind, the costs of hydro are in order for the lowest cost generation increase related to the efficiency of an
driven by the local resource and the ease options to proceed. individual station and the characteristics
or difficulty of particular sites. As such, of the fuel consumed.
the LRMC of hydro is highly project The location of new renewable and
As Figure 5 shows, the carbon charge
specific. Section 9 discusses hydro thermal generation is determined at
results in more renewables projects
generation issues in detail. least partly by the location of renewable
becoming economic relative to thermal
resources and thermal fuel. Renewable
Hydro projects are capital intensive alternatives. This is not to say that no
and take a number of years to generation is very site specific, with renewables projects would be built if a
develop. As such, economies of scale project economics hinging on the charge was not introduced. The figure
are important for project economics. resources of individual locations. highlights that prime renewables should
The LRMC of possible “economic” hydro Thermal generation is also affected by be economic even if there is no carbon
generation options ranges from $65 to location issues, with the cost of regime. However, the number of “prime”
$100/MWh. developing fuel supply chains and renewable projects is small; there are only
resource consent issues limiting practical a handful of such projects in New Zealand.
The bulk of remaining hydro
opportunities are located in the South location options. A carbon regime would enable the middle
Island and are therefore impacted by In many cases, generation projects under tier of renewables projects to be economic.
HVDC charges that add up to $10/ investigation are remote from centres of There is a far larger number of generation
MWh to the LRMC. There is about 3,500 demand, for example Southland lignite projects in this category.
GWh of potential hydro at less than station options, North Island geothermal 6. Under an LNG option, only
$80/MWh but nearly two-thirds of this generation options and lower South existing gas-fired plant would be
is located in constrained parts of the Island wind farms. These generation economically viable.
transmission grid. projects are reliant on a robust
It is expected that LNG imported
Geothermal transmission system to enable the
into New Zealand would cost more
transport of electricity to consumers.
While the geothermal fuel resource is than $9/GJ. As LNG prices are indirectly
“free”, finding and maintaining the The key transmission issue facing new indexed to oil prices and world energy
resource for the life-time of the plant can generation projects is whether demand is growing rapidly, it is
be difficult and expensive. Sites and transmission infrastructure will be built possible that the LNG price could be
fields that have a proven track record are in a timely manner to enable electricity substantially higher than this figure.
therefore more attractive than to be transported to consumers. New Figure 5 shows that at this level of price,
completely untested resources. Given generation projects can often be new gas-fired generation stations would
this, a brownfields expansion of an developed in as little as half the time it not be economic, especially under a
existing project is typically the cheapest takes to build new transmission lines. carbon regime.
page 15TABLE 2: IMPACT OF CARBON CHARGE ON COAL AND GAS-FIRED GENERATION
$15/t CO2e carbon price $25 /t CO2e carbon price
ΔLRMC Adj. LRMC ΔLRMC Adj. LRMC
Coal $13–16/MWh $88–118/MWh $23–27/MWh $99–128/MWh
Gas $6 /MWh $58–116/MWh $10/MWh $62–126/MWh
Gas price range is $4-12/GJ
Existing gas-fired plant would be include transmission lines, canals, or found, for example another Maui sized
economic, as their capital costs are gas pipelines. Land may be required field is discovered, then there will be a
sunk. However, the change in cost to provide access to the power station, greater proportion of new generation
structure of this plant would mean they or be affected as part of a hydro that is gas-fired with some renewable
may have to operate differently, possibly development. Depending on the number generation.
as mid-merit plant. It is also possible that of parties that are affected and the Under other gas scenarios, renewable
the rigid take-or-pay price structure nature of their existing land use, the generation will form a significant part of
common in LNG supply contracts could process of negotiating the sale of land or total new generation capacity and
distort plant behaviour. obtaining easements can be protracted production. In these scenarios, the best
A decision to import LNG would and costly, perhaps even impossible. new generation projects will be wind
radically alter New Zealand’s electricity • Resource consents. Obtaining the right farms in “prime” locations, hydro
generation sector. The whole industry to develop a site for generation under generation in “prime” locations and
would be linked to international energy the Resource Management Act is a geothermal expansion projects. These
patterns given the role of gas-fired significant hurdle that must be faced projects have the advantage of being
generation in the sector. The long length by all projects. Every type of generation environmentally sustainable.
of LNG contracts, typically 20 years or and individual project will have its own However, there are only a small number
more, means there would be little ability environmental issues that need to be of wind and hydro projects that fit into
to “opt out” of such an arrangement if addressed as part of this process. For this “prime” category. Many are defined
New Zealand’s fuel situation changed instance, some generation types will be as projects in “good” locations.
– for example if there was a major a permitted activity in some authorities Depending on the nature of the gas
domestic gas discovery during this time. and prohibited in others. Sometimes a environment, which will affect the price
7.4 Other Factors Affecting New district plan change is required before of wholesale gas, incentives may be
a resource consent can be lodged. required for these projects to be viable
Generation Options
Outcomes from the resource consent economically. A policy environment
The previous discussion compared the where the cost of carbon is properly
process are uncertain.
relative economics of generation options reflected is one important avenue for
as a key factor influencing the future The delays, commercial arrangements
and imposed conditions that stem from encouraging these projects.
generation mix. Other factors are also
the above two processes can change a Although the cost of various generation
important in project selection. For
project’s economics considerably or even project options is a key factor in
instance, a project will not proceed
prevent a project from going ahead. determining project selection, there are
unless the site is secured, technical
also other important considerations. The
feasibility has been completed, the 7.5 Summary
ability of a generation company to gain
proposed development is consented In general, the economic variation access to land and to obtain appropriate
and plant items and works have among various projects of the same resource consents is a critical factor that
been tendered. generation technology (whether this is affects the viability of a project.
There are two key factors that coal, gas or renewable generation) is
greatly impact on the timing and greater than the variation among
viability of projects: technologies. From an economic
• Land access. Many generation perspective, New Zealand’s future
opportunities require access to or use electricity production is likely to come
of land belonging to landowners or from a range of generation plant.
used by leaseholders who are not The share that each generation type
necessarily the developer. The land will have depends on a number of
may be required to site plant or other factors. In particular, if significant
infrastructure. This infrastructure may amounts of low-cost indigenous gas are
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