Electricity – make the demand side work

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Electricity – make the demand side work

Simon Carlaw

Soaring electricity spot prices and the threat of power shortages are making business very nervous. 

It’s crazy, but we’re suffering from high prices as if we had scarce energy resources instead of the generous endowments we do have.

We have problems accessing all forms of energy.  Our oil and gas potential is not being tapped in the wake of the run-down of the Maui field largely because of disincentives to invest in this area.   We have generous coal reserves that could be used to produce electricity but our self-inflicted Kyoto burden stands in the way.   The Resource Management Act is stopping new hydro stations from being built.  Wind and solar power technology is not yet cheap enough to provide large amounts of energy.

The short-term problem – electricity shortages because of low lake levels in the South Island – could be fixed by using coal to generate electricity, though this would increase our liability under the Kyoto Protocol.  It will be important to ensure that the carbon tax regime prompted by the Protocol is structured so that coal-fired electricity generation is not excessively penalised.

But there is a longer-term problem that’s impacting on many businesses: high, volatile electricity spot prices and no way of getting affordable forward cover.  While domestic consumers have the certainty of ‘permanent’ monthly contracts at fixed, affordable prices, businesses are buffeted by harsh spot prices.

Why can’t businesses get forward cover?  It’s largely because of those ‘permanent’ monthly contracts that domestic consumers get.  The large electricity generators that are also retailers - ‘gentailers’ - sell power to domestic customers at fixed prices that are in effect forward or hedge contracts.  This provides certainty for domestic customers and also for the ‘gentailers’ because they can sell power at a steady price independently of the risky spot market which sometimes prices electricity below the cost of production.  It amounts to a form of internal hedging for the ‘gentailers’ themselves, and removes much of the need to write hedge contracts for business customers. 

Given that, how can more hedging be made available to businesses?  There are a number of possibilities, ranging from heavy-handed regulation to more ‘light-handed’ rules.  One possibility could be to require the ‘gentailers’ that take a forward contract from their own generator to offer a proportion of the amount hedged at the same price onto the hedge market.  Such a rule could conceivably have a time limit - perhaps being used only until there is a threshold change such as the privatisation of state energy assets – to prevent it becoming something that skews the free operation of the market in the longer term.  

That’s a supply-side remedy.  But the situation also requires a demand-side remedy – something that fixes the disparity between the business consumers who receive scarcity signals in a very direct and brutal way and the domestic consumers who do not receive scarcity signals directly at all.

One answer would be to get a critical mass of domestic consumers owning time of use meters.

The stable, fixed price at which domestic consumers currently buy their power contains a healthy profit margin for all ‘gentailers’, much of which could be returned to the pockets of consumers if they had time of use meters that allowed for unused power to be sold back to the retailer.  But the meters are expensive, a few hundred dollars each, and it would take a long time before there was the critical mass of domestic consumers with such meters to begin the buyback system. 

As a remedy, the Government could instruct SOE ‘gentailers’ to provide incentives for domestic consumers to invest in time of use meters, by offering electricity at a cheaper price to those who did so.  This would help household consumers unlock substantial ongoing savings while making the wider market, not just business consumers, more responsive to energy supply. 

Demand management could be improved among business consumers too.  Thousands of business consumers already have time of use meters and a ’demand exchange platform’ that allows consumers to sell back power is already being used by Meridian customers.  Largely all that’s required for a general demand exchange to be set up is the institution of market rules to govern it.  This requires an effective governance regime – something that has been years in the coming.  This month industry players will either vote for a self-regulation regime or the Government will institute its own regime.  Either way, once a governance regime is under way, rules for demand management can then be agreed.

Once that happens we can begin to move, fast or slowly, towards an improved energy market where major savings can be made from demand management.  Distortions between business and domestic consumers can then be overcome and the ravages of the spot market insured against. 

Business wants the current energy mess resolved sooner, not later.

Simon Carlaw is Chief Executive, Business NZ