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The Operation and Performance of the New Zealand
Electricity Market
Economic and physical environment matters for: operation, outcomes and evaluation of outcomes
Lewis Evans
Victoria University of Wellington
12 December 2013
Conference
Applied and Theoretical Economics
Competition Policy Issues: Theory Meets Practice
Massey University Albany
Outline
1. The Market
2. Forms of risk and implications for
1. Market performance
2. Modelling market performance
3. One approach: or how the spot market allocates
water (and gas)
4. Comment on performance
NZ Electricity Market 2013
Energy only Market, no taxpayer-as-taxpayer- funded investment,
risks assigned to those best able to manage them
Households produce the peaks
Oligopoly: 5 large firms + fringe competition: workable
Generation
Customers
Transmission
competition.
1/3 households and 1/3 commercial firms &
1/3 large industrials
(Retail)
(National HV Grid) Natural monopoly SOE
(investment/prices regulated by the Commerce Commission)
(Local LV Grid) Natural monopoly
Distribution
(cooperatives/regulation Commerce Commission)
Buyers & Sellers
• 14 retailers (4 not gentailers: 22 brands)
• Generation
– Greater than 1MW: there are 140 plant owned by 36
separate companies (operated by 19)
– Less than 1MW: small (at least 80, micro plant embedded in
networks)
• Traders spot: 32 distinct buyers or sellers
• Traders Futures (ASX): 12 distinct traders: 5 of which are not
market participants
Source EA June 2013
Managing Volatility and Its Implications
The wholesale market: spot, forward and capacity
Anticipated
Spot price
characteristics
Supply cost of generation
plant/fuel, Demand, Climate
and events
The Future
Capacity
Investment
Spot Prices
Forward Prices
Inflows, Storage
Short term demand
supply and transmission events
The Present
Volatility Indicator
Vector North Gas Pipeline: Daily Gas Throughput
Volatility (thermal generation: water/temperature): across years/seasons/weeks
( source Concept Consulting)
70.00
01/07/31
01/10/33
01/01/36
01/04/38
01/07/40
01/10/42
01/01/45
01/04/47
01/07/49
01/10/51
01/01/54
01/04/56
01/07/58
01/10/60
01/01/63
01/04/65
01/07/67
01/10/69
01/01/72
01/04/74
01/07/76
01/10/78
01/01/81
01/04/83
01/07/85
01/10/87
01/01/90
01/04/92
01/07/94
01/10/96
01/01/99
01/04/01
01/07/03
01/10/05
NZ-specific characteristic
60% is hydro generation with limited storage
and very volatile water supplies
There is huge variation
Monthly Inflows 1931-2006 (GWhrs/100)
60.00
50.00
40.00
30.00
20.00
10.00
0.00
Regional Water Flow Characteristics
Implications: I
1. The risky economic environment enhances competition in
the spot and hedge markets: different firms have
different cost structures (water and other) that vary
unpredictably over time rendering cooperation more
difficult
2. Hedging will be an integral part of the wholesale market:
1. Across time
2. Across space
3. In competition with capacity investment (in generation
and storage)
More on: Spot and Hedge Prices
• Transactions
occur largely
at value
the fixed
hedge
price water
The spot electricity
price =>
of unit
of stored
• Generators are short of water in dry years: which can
A
hedge
(for some quantity) and spot prices
be$50
very
costly
Spot market is a nationwide water market valuing use
• The high
price episodes do not imply market power or
in electricity
rent to generators
We observe no dry-year generator cash
profit humps
Generators and
Buyers can each win and lose with dry weather
Operating Cash Flow (excluding interest)
After tax, before capex, asset, financing transactions. In $m. constant (cpi)
prices and aggregate spot throughput
(Contact 2005 9mths)
1400
1200
1000
Trustpower
800
Mighty River
600
Meridian
400
Genesis
200
Contact Energy
0
FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012
Implications: II
1. Spot market-measured profit distribution outcomes
in general do not translate into actual profit distribution
outcomes in the long or short run
2. Modelling the spot market should
1. explicitly recognise uncertainty
2. recognise that decisions by generators
will be taken in trading periods based on information that
includes
* amount of stored water,
* inflows and
* forecastability of inflows (at least days – or many
trading periods – ahead)
Application
A(nother) model of the spot market
in continuous time
Model: behaviour
• Competitive behaviour equivalent to social planner choice
• For any trading period choose on- and off-peak hydro and gas
generation to maximise the expected present value of total surplus:
- looking forward to the indefinite future
- given the model’s structure, the distribution forecastibility of
inflows, levels of current inflow and storage
- given a defined opportunity cost of gas, & ignoring competing
uses for water
• Planner’s choice produces gas and hydro generation policies
Model: generation policies
in each trading period
• The combined cost of hydro and gas generation is minimised and
consumer price equals marginal cost (typically) of water and gas
• The spot market valuation of water is the price of the last unit of stored
water that renders generators indifferent between generating
today or waiting:
ie value of use today equals
- the expected present value of use in some future period,
and
- the value of the option to use in the future
Model: Value of Water
Model calibrated to 2007
Outcomes from 200 years of simulated daily (full trading) periods
s
•
is the proportion of storage to capacity
• The upper curve relates to very low inflows
• The lower curve relates to very high inflows
Model: Generation Policies:
Dry Year: all gas used before hydro
Demand 1 Demand 2
Marginal cost
Price
Gas
Water
Given storage
Demand predictable
Model: Generation Policies:
Normal Year gas then hydro then gas
Demand 1 Demand 2
Marginal cost
Price
Gas
Water
Given storage
Demand predictable
Implications: III
Where there is significant volatility in water (gas) supplies
and storage
1. a rational expectations spot market has no exogenous
supply curve: the level of demand affects storage and
the position of the supply curve (no matter how competitive
the market)
2. studies of particular outcomes have limitations in that
decisions are forward looking in the context of variance & risk:
improvable realised outcomes do not of themselves
indicate choices were inefficient.
Model: Intra Day Spot Market Water Allocation
light-shade without reservoir || dark-shade with reservoir
Outcomes from simulations
Model: Seasonal Water Allocation
light-shade without reservoir || dark-shade with reservoir
Outcomes from simulations:
Implications: IV
The spot market has a socially useful role
1. Complements hedges providing transactions in
unders/overs
2. Prices water in electricity production in almost real time
across regions
3. Allocates water (relative to gas) over time in electricity
The model described has uses based on a
presumption of efficient decisions: could be tested on
distribution of outcomes.
Comment on Performance
The Hedge/Contract Market
Evidence is a) that hedge price closely approximates next
cheapest generation option: as it should in a
stable/growing market. b) Capacity investment has
matched supply to demand,
The NZ Cost of Electricity
Comparisons across Countries [EA March 2013]
Are fraught with issues
a) definitional what is the price paying for?
b) exchange rate issues: why vary them over time?
(adjusting for the change in the TWI since 1999 NZ has the same ranking in 2012 as in 1999)
c)
domestic fuel supply conditions
Factors Affecting Residential prices
1990-2013
• Better reflect cost of electricity delivery
• Corporatisation changing the subsidy->price
• Peakiness requiring capacity
• Open ended contracts (insurance)
• Competition in retail and the wider market
Harker 2013
Final Comments
•Present arrangements: the electricity market has
technological change in prospect that creates risk and the
prospect of beneficial outcomes
•Regulatory Risk: the subsidy-single buyer model has two
strands: a subsidy for electricity, and return to government
management of the market. It has deleterious effects on
economic performance and the environment. It is most
unlikely to foster beneficial outcomes of technological
advance.
Bibliography
Concept Consulting Group, Gas Supply and Demand Scenarios, 2012 – 2017, 2012, 122p.
Evans Lewis, Graeme Guthrie and Angela Lu, “The Role of Storage in a Competitive Electricity Market and
the Effects of Climate Change”, Energy Economics, 36, 2013, 405-418.
----, Seamus Hogan and Peter Jackson, “A Critique of Wolak’s evaluation of the NZ electricity market:
introduction and overview”, New Zealand Economic Papers, 46(1), 2012, 1-11. Introduction to a
symposium of several papers on Frank Wolak’s Commerce Commission consulting report.
---- and Graeme Guthrie, "How Options Provided by Storage Affect Electricity Prices”, Southern Economic
Journal, 75(3), 2009, 681-702.
-----, The Economic Effects of the Price-Discriminating Single Buyer : Presentation to the Victoria
University Institute of Policy Studies, (www.iscr.org.nz), July, 2013.
Grimm Veronika, and Gregor Zoettl, Investment Incentives and Electricity Spot Market Competition,
Journal of Economics and Management Strategy, 22(4) 2013.
Harker, Bruce, Address to Trustpower AGM, July 2013
(www.nzx.com/companies/TPW/announcements/239025)
Philpott, Andy and Ziming Guan, “Models for Estimating the performance of electricity markets with hydroelectric Reservoir Storage”, mimeo, EPOC, Auckland University, 2013, 44p.
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