Safeguarding electricity supply

Thursday 29 May 2003

By the Electricity Group, Bell Gully

On 20 May, the Government announced new measures to safeguard future electricity supplies, including the establishment of a new Electricity Commission. We have summarised the key points of this announcement below.

Overview- establishment

• An Electricity Commission will be formed and directed to ensure that the industry operates to a "1 in 60" dry-year security standard.



• The Commission is expected to be a statutory commission with the powers of an Electricity Governance Board as outlined in the Electricity Amendment Act 2001.



• Seven commissioners are due to be appointed by the end of August 2003.



• A legislative package is due to be introduced in August or September.



• The Commission will contract with generators for the provision of dry-year reserve generation capacity and fuel.



• The Commission will receive the spot price when the ring-fenced capacity is dispatched by the system operator.



• The Commission's net costs will be recovered through a levy on market participants - estimated at well under half a cent per unit of electricity.



• The Commission will be given an additional "toolbox" of powers to deliver on its security objective.

Contracts for security reserve

• The Commission will contract by tender for a quantity of new and/or existing generation as a "security reserve" to be set aside or ring-fenced from the market. The Commission will determine the prices and quantities offered to the market by this ring-fenced capacity.



• The Commission will be expected to hold a mixed portfolio with capacity at different locations and with different fuel types in order to manage the impact of contingencies such as disruptions to fuel supplies.



• Reserve generation is expected to comprise new plant with relatively low capital costs, plus heavily depreciated old plant.



• The necessary portfolio of reserve generation is expected to be built up within about three years.



• Payments from the Commission under the ring-fencing contracts will cover the capital and maintenance costs of the plant and the cost of fuel.



• Competition in generation will be encouraged by a legislative amendment enabling owners of electricity lines businesses to invest in reserve generation without limit as to quantity.



• The competitive bidding process is expected to ensure that the owners of ring-fenced reserve capacity do not earn profits above or below their risk-adjusted cost of capital.



• Some of the Commission's contracts for reserve capacity may be of a sufficiently long-term duration to be capable of backing the construction of new "hydro-firming" plant. Contracts involving existing generation capacity are likely to be shorter but may still cover multiple years.



• Contracts for reserve capacity are expected to include provision for regular audits by the Commission concerning plant and fuel availability, and severe penalties for breaches of contract.

Dispatch of reserve capacity

• Reserve capacity is to be sold on the spot market.



• There are some important considerations relating to the Commission's offer price into the spot market for reserve generation. If the generation is offered at too low a price, this may reduce the commercial incentives to build new high load-factor plant or invest in demand-side management, as an effective cap would be established at a low price. However, if the reserve is offered into the market at a price significantly above its short run marginal cost, the reserve capacity will be used less frequently (even though it may be efficient to operate it more frequently), and spot prices will be higher than necessary.



• A further option may be to offer the generation in tranches at different prices. An initial tranche of the ring-fenced reserve generation might operate relatively frequently (for example, when inflows were below mean and/or lake levels were relatively low for that time of year). Subsequent units of ring-fenced generation would have a progressively lower load factor. The last units of ring-fenced generation would run very rarely.



• The Commission might also have discretion as to whether to maintain a standing offer price into the spot market, or whether it may vary the offer price on the basis of its assessment of the risks of supply shortages.



• The ring-fenced capacity will be fully committed, providing an effective cap on the spot price to the whole market (with the costs met by a levy on all market participants).

Net cost recovery- consumer levies

• The Commission will have the power to recover the cost of reserve generation in the manner it judges to be most efficient, for example through a levy.

The "tool box"

• The Commission will have additional powers in its "toolbox" to deliver security of supply. These powers will be available as a backstop to help the Commission ensure that the market operates as efficiently as possible.



• The toolbox includes power to set minimum requirements on generators to hold dry-year reserves and long-term financial contracts. The Commission will also be able to set minimum requirements on retailers and major users to hold long-term financial contracts and/or maintain programmes for reducing demand when spot prices rise.

Other powers and functions

• The Commission will be empowered to require generators to offer long-term electricity hedge contracts into the market, for a nominated proportion of their reliable capacity, if it decides this is necessary to safeguard against under-investment in ordinary generation.



• The Commission will pick up routine governance functions from existing industry bodies. Commencement rules for the Commission will be based on the rulebook developed by the recent industry processes, suitably amended to take account of the establishment and decision-making role of the Commission. Draft commencement rules will be put out for a brief period of consultation by the end of June.



• The Commission will be responsible for improved modelling and forecasting of future electricity supply and demand.



• It will also have new powers to require disclosure of information including coal stockpiles and more timely data on gas discoveries and reserves. It will require publication of amalgamated figures for the total quantity and price of all hedge contracts.



• It will also be charged with improving the industry's ability to manage ripple control for water heating.



• Urgently address transmission investment and pricing. The national grid is in a mostly satisfactory shape, but there is no agreement in the industry about who is responsible for making decisions about new transmission investments and who should pay for them. This means that when new transmission investment is needed Transpower has no certainty it can get paid for it, which means Transpower is under-investing in the grid, or soon will be.

If you would like to know more about the new Commission and how it may affect your organisation, please contact the Bell Gully Electricity group.

Click here to read the Government announcement and discussion paper.

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