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The importance of new entrants in the New Zealand electricity market

Paper to the 8th Annual New Zealand Energy Summit

17th July 2006

Presented by: Bill Heaps – Strata EnergySimon Hope - NZIERJuly 2006

In association with:

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Contents

The role of new entrants and their relevance to the NZ electricity market

The potential for new entrant generation Channels for selling output from independent

generation Barriers to market entry Role of independent retailers, brokers and aggregators Summary

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Role of new entrants

Innovation Increased consumer choice and discipline on quality Discipline on prices Increased efficiency Reduced regulationAdditional employment opportunities

What is the relevance of each of the above benefits to the NZ electricity market?

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Context – NZ energy supply situation

New Zealand’s energy markets are or are becoming constrained Electricity (primary energy, generation, transmission, distribution) Gas (exploration and supply, transmission, distribution) Oil (production, refining, transmission, distribution)

Forecasts 2006 – 2010 prices strengthen as constraints appear and

concerns rise 2010 – 2015 significant risk of supply curtailment and constraints

if infrastructure investments have not been made Carbon emissions controls may compound the situation Consenting and approval processes make difficulties for

infrastructure investments

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Context – Supply and value chains

Traditional supply chains may struggle to meet demand and environmental objectives

The need for innovation and investment in non-traditional energy supply and demand management will increase

Aggregation and facilitation service providers will be needed to establish capability for smaller players to enter energy markets

New energy efficient products and services will be developed and marketed

The value chain will flow in both directions (supply – demand – supply)

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Context – One perspective of the current supply chain

TraditionalEnergy

Producers Wholesale Retail Demand

Supply to demand flow - no return path Little demand response and participation Barriers to smaller independent suppliers Lack of liquidity, minimal innovation and

inefficient use of resources

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Characteristics of existing players

They have both generation and retail businesses They have multiple generation assets at different

locations Their retail customer bases tend to be located close to

their generation (e.g. Meridian Energy dominant in the South Island, Mighty River Power dominant in Auckland)

They have large retail bases providing economies of scale

They are large enough to have wholesale and retail market obligations through their own resources

They sell their output through a portfolio of hedge contracts and wholesale spot market.

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Characteristics of potential new entrants

They are likely to be stand alone generators without retail capability

They will have generation assets at a single location They may need to sell their output to customers remote

from the physical location of the generator They may have no retail base to provide hedging and will

find it hard to create one with economies of scale They may be too small to have internal resources

sufficient to manage the wholesale and retail market obligations

They may seek to sell their output through a single long term contract.

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Channels to market

1. Offering output to the existing major generators

2. Selling to major users

3. Selling on the spot market

4. Selling via mass retail

The paper provides a view on the relative advantages and disadvantages of each channel.

Large generator/retailers use a combination of all channels

Independent single generators tend to access only option 1

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Barriers to entry

Technical Scale, reliability, location, availability, intermittency, Impact on system quality compliance with network connection

requirements System constraints and capacity availability

Market Costs of being a market participant Retail scale economies Fuel supply uncertainty Prudential risk management Nodal price risks

Regulatory Compliance Exemption applications Levies and other charges Standards and technical requirements Uncertainty

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Market charges (2005 base)

Ancillary Services Paid By Black Start 234,460$ Grid Owner Frequency Keeping 43,738,912$ Purchasers Over-frequency Reserve 423,850$ HVDC Instantaneous Reserve 9,744,452$ Generators and HVDC Voltage Support 3,607,854$ Dispensated Generators and Distributors

Commission Levies Paid By Applicable $/MWhCommon quality operations Generators, Purchasers, Distributors and Transpower $0.1219Market operations Generators and Purchasers $0.3009Registry and consumer operations Purchasers and Distributed $0.0000Supply security operations Purchasers $0.0000Transmission operations Transpower $0.0000Electricity efficiency operations Purchasers $0.0000Other activities MACQS reform operations Generators, Purchasers, Distributors and Transpower $0.0236Commission Levies Subtotal

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Example 1 - 60MW unit generator only (North Island)

Ancillary Services Paid By Rule

Estimated Allocable Costs for 60 MW Generator

Black Start Grid Owner C, IV, 11.2 -$ Frequency Keeping Purchasers C, IV, 11.4 -$ Over-frequency Reserve HVDC C, IV, 11.3 -$ Instantaneous Reserve Generators and HVDC C, IV, 11.5 -$ Voltage Support Dispensated Generators and Distributors C, IV, 11.6 3,007$ Ancillary Services Subtotal 3,007$

Commission Levies Paid By Applicable $/MWhCommon quality operations Generators, Purchasers, Distributors and Transpower 0.12$ 60,950$ Market operations Generators and Purchasers 0.30$ 150,450$ Registry and consumer operations Purchasers and Distributord -$ -$ Supply security operations Purchasers -$ -$ Transmission operations Transpower -$ -$ Electricity efficiency operations Purchasers -$ -$ Other activities MACQS reform operations Generators, Purchasers, Distributors and Transpower 0.02$ 11,800$ Commission Levies Subtotal 223,200$

Totals 226,207$

Note: If the generator also retails then a share of ancillary services costs will be incurred

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Example 2 - 1MW unit generator only (North Island and South Island)

Ancillary Services Paid By Rule Estimated Allocable Black Start Grid Owner C, IV, 11.2 $0 Frequency Keeping Purchasers C, IV, 11.4 $0 Over-frequency Reserve HVDC C, IV, 11.3 $0 Instantaneous Reserve Generators and HVDC C, IV, 11.5 $0 Voltage Support Dispensated Generators and Distributors C, IV, 11.6 $0Ancillary Services Subtotal $0

Commission Levies Paid By Applicable $/MWhCommon quality operations Generators, Purchasers, Distributors and Transpower $0.1219 $961Market operations Generators and Purchasers $0.3009 $2,372Registry and consumer operations Purchasers and Distributed $0.0000 $0Supply security operations Purchasers $0.0000 $0Transmission operations Transpower $0.0000 $0Electricity efficiency operations Purchasers $0.0000 $0Other activities MACQS reform operations Generators, Purchasers, Distributors and Transpower $0.0236 $186Commission Levies Subtotal $3,519

Totals $3,519

Note: If the generator also retails then a share of ancillary services costs will be incurred

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The roll of independent retailers, brokers and aggregators

There are two key barriers that prevent the emergence of retailers that are independent of major generators:

Hedge availability ‘to sell to customers you need hedge contracts – to

get hedge contracts you need customers’

Wholesale/Retail margin

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Wholesale/Retail margin

Metering, meter reading and data management Billing, debt collection and back office operations Call centre costs Complaints management and membership of an

approved complaints system Electricity Commission levies and EGR compliance Marketing, customer acquisition and retention

As an example, we have calculated that a retailer with 40MW base load hedge contract to sell in the upper North Island would need to service their customers at a cost below $150/year to breakeven. The $150 would need to cover:

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Brokers and aggregators

Wholesale market trading Offer and dispatch Prudential management Market and price modelling Transmission management Call centre/customer service

Aggregation is the action of combining many small components to gain the benefits of scale that are enjoyed by major players. Small distributed independent generators could be provided with common services via a broker/aggregator. Through an aggregation service, economies of scale may be realised via:

Metering and data management Retail sales and marketing Hedge contract balancing Reconciliation Invoicing and billing

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Summary

New Zealand’s electricity market is characterised by a small number of major generator/retailers with few smaller new entrants in both generation and retail

New Zealand’s electricity market was designed around large scale participants. Simple connection and market participation arrangements for smaller players do not exist. The complexity and cost of compliance with the market arrangements makes it difficult for new entrants to gain sufficient economies of scale to cover market entry costs.

Aggregation of smaller generation projects and retail services may emerge to provide new entrants with the opportunity to access the wholesale market and retail customers yet remain independent. The emergence of aggregators may depend on the development of market arrangements that enable the full benefits of distributed generation and demand response to be channelled to those that provide them.

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Questions???