Electricity is a vital economic enabler and our electricity market is well-regarded internationally. But like all markets, New Zealand’s electricity market is designed to reflect underlying supply conditions. In the same way as the price of seasonal produce fluctuates with supply, so do wholesale electricity prices. The wholesale (spot) market reflects when there is abundance, and when there is scarcity, through low and high prices respectively. The hedge market prices the expectations of future abundance and scarcity.  

In situations like now, where we are experiencing low supply, the spot market helps generators to schedule generation that reflects scarcity. So, with low hydro inflows and reduced gas availability, generation is priced more highly to reflect this scarcity, and the spot price increases accordingly. This in turn encourages generators who can procure fuel, to do so. It also ensures that all generation that can generate does, reducing the chance of running out of fuel. 

There has been a lot of public commentary on high spot electricity prices and security of electricity supply – some of which is inaccurate. The Authority is taking the opportunity to correct some of these misperceptions and to update you on our response to increased market volatility and periods of high prices. Our review of the wholesale market has been re-focussed to include competition in the spot market and will investigate the structure, conduct and performance of the spot market since 2018. This review will be released in the third quarter of 2021.

Some key points about the market and prices are clarified below.  

While Australia has lower energy prices, its industry is heavily subsidised

Australia’s electricity market is completely different from New Zealand’s. Australia’s electricity is mainly supplied via thermal (gas and coal) generation, with significant amounts of solar, wind and hydro in some states. Their renewable generation is also heavily subsidised and their thermal generation does not pay for emissions - New Zealand’s thermal generators pay for theirs. Australia went through a period of high prices following the closure of major thermal generating plant in 2017 but this reversed following installation of large amounts of subsidised wind and solar.

Around 60% of New Zealand’s electricity is supplied via hydro – when hydro lake levels are low for the time of year, as they are now, prices are high. Prices are also high this year as there are gas supply issues, which means some thermal generators cannot run as often as they want to, and now a thermal generator is out for maintenance. The highest prices experienced have also been on still days when there is a lack of wind generation. In this way the market is doing the job it is designed to do, reflecting lower levels of supply – hour by hour and day by day. 

While there is a large amount of coal being used for generation now, this is not setting the price for generation. The price is being set in most cases by gas generation which reflects the current scarcity of gas supply. Thermal generators can store gas for future use, and they are doing this to ensure availability for the winter. The price is also being set at times by hydro generators, as they value water highly, to conserve it to ensure availability in the winter. 

While there are some similarities to previous periods when there were very high spot prices, such as 2008 and late 2018, the following issues are unique to 2021:   

  • Gas supplies are reduced and the spot price for gas is higher than historical averages. All available gas is contracted, and users including some generators have had to accept a reduction in their contracted quantities. This is largely a consequence of a deterioration of output from the Pohokura gas field not anticipated so early in the field’s life cycle. 
  • Carbon prices are nearly $40 per unit, up around 50% from a year ago, flowing into the cost to run generation and the prices that this is offered to the market.   
  • Wind generator output has been lower than normal for this time of year. As wind generation cannot normally be controlled or stored, it is usually fully dispatched when available, displacing other more expensive generation.
  • A La Niña year weather pattern is happening and generators are experiencing lower inflows than in normal years.

New Zealand’s prices for industrial consumers are in the middle of OECD countries.

We have seen people comment that New Zealand has one of the most expensive wholesale markets in the world. This statement is likely to be based on the current supply conditions and is not true over the long term. 

Generally, New Zealand is at about the middle of the OECD countries in terms of energy prices for industrial consumers. In addition, we have a well-developed forward market where purchasers can get forward contracts that insulate them against high spot prices. In our market these periods of high spot prices are expected at times because our renewable generation has limited storage and is due to the inevitability of dry seasons. 

If large industrial consumers hedge on a short-term basis, they can be exposed to high prices when they purchase new hedges, or if they decide not to hedge and instead purchase electricity directly from the spot market. The reality is that prudent purchasers insulate themselves from spot prices using forward contracts. Last year, when contracts for 2021 were at times as low as $55, prudent purchasers bought heavily. This resulted in record levels of “open interest” on the futures market, and unusually large amounts of this is for 2022 and beyond. This is an example of parties seeing low prices and acting. That some purchasers chose not to hedge - despite there being a La Niña weather pattern and ongoing issues with Pohokura - is not an issue with the wholesale market. 

Unlike electricity markets in many other countries, the New Zealand electricity market is not connected to other markets as we are geographically isolated. This means if we are experiencing issues, we cannot import electricity from areas that are not facing the same challenges.
The New Zealand electricity market is also unsubsidised, unlike many other electricity markets.  

Given the sector is grappling with constrained fuel, the resulting spot prices are high, but not unexpected. Current spot prices reflect generators conserving fuel for use in the winter when demand is higher. Any other response in a scarcity situation would suggest the market is not working. 

Given the current situation, the Authority, as kaitiaki of the market, is reviewing various aspects of the market and its settings.

The Authority is improving the trading conduct provisions 

The Authority is proposing changes to the current high standard of trading conduct rules to better manage circumstances where competition is weak. 

There is general agreement that the existing rules are vague and open to interpretation. As a result, the Authority is considering changes, which, if confirmed, would be introduced in the near term. 

There is also work underway by the Authority because of the Electricity Pricing Review, particularly around transfer pricing between generation and retailers, to help ensure both generation and retailing are competitive, and there is greater transparency of profitability.

Generators are building new generation that will lower prices
 
The wholesale market signals the status of the demand and supply balance, and the value of potential new investment at various times and in various locations. 

The Authority’s focus is on making sure the market sends the right signals about the cost of electricity to New Zealand businesses and consumers, ensuring the right technology and infrastructure investments are made at the right time and in the right place.

And generators, including independent ones, are certainly building generation as a result. Top Energy is expanding its geothermal plant, Eastland Energy has built a geothermal plant and Mainpower is building wind generation. Tilt Renewables has just completed a major wind development.

And so are some of the bigger players - Contact has recently announced a new geothermal plant at Tauhara, costing $580m, and Meridian has announced the Harapaki windfarm, costing $395m. Also, Mercury is in the middle of building the $464m Turitea wind farm and planning more development at Puketoi. 

These plants have low marginal costs and will force out higher cost generation, meaning more hydro generation can be stored for when inflows are lower. 

The Authority is investigating the spot market, asking the question: Are prices efficient? 

The Authority is thinking and acting more broadly to ensure we respond to a changing electricity sector, and the imperatives of climate change and economic recovery. The electricity wholesale market has a key role to play in an orderly and accelerated transition. 

The Authority is focused on the performance of the electricity market, including its ability to support a level playing field to bring on new generation investment and to send the right signals about the cost of electricity to New Zealand businesses and consumers. 

In response to increased market volatility and periods of high prices, the Authority is refocusing the review of the wholesale market. The review will focus on competition in the spot market and whether prices are being determined competitively. This will include looking into the structure, conduct and performance of the spot market since 2018. 

Due to the complexity of the review, and the detailed forensic analysis involved, the review will be released in the third quarter of 2021.