Economic Assessment of Puketoi Wind Farm doc

Executive summary This report provides an assessment of the economic effects of the proposed Puketoi wind farm by Mighty River Power, for the purpose of informing application for resourc

Economic Assessment of Puketoi Wind Farm

Report to Mighty River Power

July 2011

8 Halswell St, Thorndon

P O Box 3479, Wellington Tel: +64 4 472 1880 Fax: +64 4 472 1211 econ@nzier.org.nz www.nzier.org.nz

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NZIER is also known for its long-established Quarterly Survey of Business Opinion and Quarterly Predictions

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Authorship

Prepared by: Peter Clough & Daisy Shen

Quality approved by: John Yeabsley

Version: 5

Acknowledgements:

Executive summary

This report provides an assessment of the economic effects of the proposed Puketoi wind farm by Mighty River Power, for the purpose of informing application for resource consent Given the focus of the RMA (RMA) on sustainable development, economic efficiency of resource use in section 7 (b) and on the benefits of renewable energy in section 7 (j), it uses a framework of cost benefit analysis for assessing these effects

The proposed Puketoi wind farm is likely to inject $138 million to $171 million expenditure into the local economy directly, and create 500 jobs locally during the construction phase, and also add $12 million to $21 million per year of direct expenditures once in operation Such economic impacts can be significant in stimulating economic activity more widely, but they are not unique to a given development, and they are not informative about efficiency of natural and physical resources

More relevant for RMA considerations is the stream of benefits derived from the new wind farm once it is operational, which stem from the harnessing of a hitherto free resource (wind) to create a valuable commodity (electricity) This has implications for those involved in supplying electricity, the consumers of electricity, and also third parties dealing with its effects on the wider environment

The fact that Mighty River Power wants to invest in Puketoi wind farm indicates that the company regards it as an efficient use of its resources The critical question for RMA purposes is whether Puketoi wind farm would create effects external to the company’s consideration that are so significant as to outweigh the efficiency benefit

of its use of natural resources

In summary, the new wind farm would alleviate electricity supply risk caused by recurring dry years, and contribute to stated government objectives for increasing renewable generation and reducing greenhouse gas emissions, as expressed in the New Zealand Energy Strategy and the framework for greenhouse gas emissions trading Its economic effects can be expected to be:

Recovery of the wind farm operator’s long run costs from the viability of the project as they would from any other investment, with a share of this going as enhanced benefit for those who receive rentals for the land it occupies;

Minor benefits for power consumers, through:

• suppression of price rises, due to displacement of higher cost generation sources;

• Defered grid investments and reduced transmission losses, any savings from which would potentially pass through to all power consumers;

• More than minor benefits from displacement of long distance power transmission with associated losses;

Benefits, probably of substantial value, from the displacement of thermal generation and avoidance of greenhouse gas emissions which comprise:

• benefits to the wind farm operator to the extent the emissions trading scheme exposes emitters to the full cost of emissions under the Kyoto Protocol and any successor international agreement;

• benefits to third parties (e.g New Zealand tax payers) to the extent that emitters are shielded from full cost of emissions by the government taking some responsibility for meeting international obligations (as is currently the case given the cap on emission prices under the emissions trading scheme), or should the current government policy change in ways that shift liability for greenhouse emissions away from the emitting sectors;

A balance of third party effects including:

• Potential disruptions to the site, mostly temporary, internalised in landowner agreements and hence less than minor;

• Potential displacement of recreation and tourism activities, likely to be less than minor, and possibly beneficial should the wind farm site attract sight-seers;

• Potential impacts on visual amenity, wildlife habitat etc (not assessed in this report)

Quantified estimates are provided based on the assumed installed capacity of

159-326 MW The value to New Zealand of this new generation is indicated by the costs

of the next best alternative, assumed to be thermal generation

Contents

1.  Introduction 1 

2.  Framework of analysis and assumptions 3 

2.1  Economics, Policy and the RMA 3 

2.2  Components of economic assessment 4 

2.2.1 Components of cost benefit analysis of a wind farm 4 

2.2.2 Components of economic impact analysis of a wind farm 5 

3.  The existing environment 7 

3.1  Electricity supply and demand in New Zealand 7 

3.1.1 Forecast growth in electricity demand 8 

3.1.2 Expected increase in generation capacity 10 

3.2  The role of wind in meeting electricity demand 14 

3.3  National objectives and policy for electricity 16 

4.  Assessment of actual and potential effects 20 

4.1  Puketoi Wind Farm and the local economy 20 

4.2  Value of wind generation obtained from Puketoi wind farm 24 

4.2.1 Wind power effects on the electricity system 27 

4.2.2 Other potential effects of Puketoi wind farm 29 

4.3  Assessment of costs and benefits relevant to RMA 29 

4.3.1 Effects on producers 30 

4.3.2 Effects on consumers 31 

4.3.3 Effects on third parties (environment) 33 

4.4  Assessment of the proposal against RMA’s criteria 35 

5.  Conclusions 38 

Figures Figure 1 Current generation across New Zealand 7 

Figure 2 Electricity consumption forecasts 2009-2025 9 

Figure 3 Mean monthly wholesale electricity prices 10 

Figure 4 Recent trends in fossil fuel prices 12 

Figure 5 Employment in national and local economies 23 

Figure 6 Thermal generation and emission Costs 27 

Figure 7 Summary of economic effects 36 

Figure 8 Summary of national and local benefits 39 

1 Introduction

This report sets out a comprehensive economic assessment of the proposed Puketoi wind farm development, with particular reference to matters contained in Part II and section 104 RMA The proposed wind farm would be located along a ridge of the Puketoi Range to the east of Woodville and Pahiatua The electricity it generates would feed into the national transmission grid at the Linton Substation located between Palmerston North and the northern Tararua Ranges The proposed wind farm development envelope has 53 turbines, giving an installed capacity of 159-326 megawatts (MW)

Depending on the wind resource and efficiency of operations, wind farms in New Zealand can achieve utilisation of between 33% and 45% Existing wind farms at other nearby locations have achieved utilisation rates at the upper end of this range, and due to the exceptional quality of the wind resource the same is expected for the Puketoi wind farm Current expectation is that it is capable of producing 706-1272 GWh per year with a utilisation rate of 44.5%

The purpose of the wind farm proposal is to harness a hitherto free natural resource, wind, to create a valuable commodity, electricity This is of value to the wind farm’s operators, but also the wider community to the extent that it contributes to generation capacity available to meet demands across the electricity system, and avoids the resource costs and consequences of alternative generation

As well as creating value by capturing the wind resource, the proposed wind farm will also inject funds into the local economy, particularly during its construction stage, and

to a lesser extent during its operation Critical variables on these local economic impacts are its capital cost (and its staging over the construction period), its on-going expenditures (particularly those on services and supplies that can be procured locally), and the direct jobs created in both the construction and operation of the wind farm Site occupancy rental payments to landowners is another source of economic impact (or rather a particular form of local procurement expenditure)

As the RMA entails balancing tangible effects against less tangible ones, some estimates of the likely magnitudes of measurable benefit are useful to the process of reaching a decision Mighty River Power operates on commercial principles and will not proceed with Puketoi wind farm unless it continues to expect it be of private benefit to the company’s returns So the economic issues of most interest for resource management purposes are the likely external effects, i.e those that are outside the consideration of the developers In the current case these include:

• The balance of environmental effects, both local effects (like effects on landscape amenity) and global effects (like greenhouse gas emission displacement)

• Potential savings across the energy supply system

• Potential value of the synergies obtained from co-ordinating Puketoi wind farm with other generation plant (e.g hydro schemes)

• Achievement of stated objectives of government, such as those in the New Zealand Energy Strategy

Forecasting the likely uses of wind power in the future is a complex task, but it is possible to provide illustrative examples of the economic consequences of Puketoi wind farm, including cost savings, carbon emission reductions and changing patterns

of supply caused by a new wind farm, given plausible assumptions about how the market would operate with and without it

This report proceeds by:

• setting out a framework for considering economic effects (section 2);

• outlining the existing environment that the proposed Puketoi wind farm will affect, with particular attention to the electricity supply and demand (section 3);

• assessing Puketoi wind farm’s contribution to national economic well-being (section 4);

• concluding with an overall assessment of Puketoi wind farm’s economic effects (section 5)

Sections 2 and 3 are by way of background on the general legislative, policy, and electricity situation in New Zealand Sections 4 and 5 are specific to the Puketoi wind farm proposal, based on current expectations and available information

2 Framework of analysis and assumptions

The principal purpose of a wind farm is to harness a free natural resource (wind) and convert it to something of value to people (electricity) There are beneficial consequences of this for wind farm operators, but also a variety of effects on third parties and the wider environment, all being relevant to considerations under the RMA

2.1 Economics, Policy and the RMA

The purpose of the RMA is to promote the sustainable management of natural and physical resources The RMA defines sustainable management as using resources in

a way that enables people and communities to provide for their well-being and their health and safety, while sustaining the potential of those resources to meet reasonably foreseeable future needs and avoiding, remedying or mitigating any adverse effects of activities on the environment

There is an established body of case law which highlights the several distinct threads

in the RMA which take what the Environment Court in the Marlborough Ridge case (Marlborough Ridge Limited v Marlborough District Council [1998] NZ RMA73) described as an “economic” approach to sustainable management These include Section 5(2) references to “enabling” and “economic well-being”; Section 7(b) references to efficient use of resources; and references in Section 32 to effectiveness, efficiency, and assessing benefits and costs While the latter is not strictly relevant to consideration of these applications, together they impart a pronounced economic complexion to the RMA

Recent changes to Section 7 RMA are particularly relevant to the application for consents for wind farm developments such as Puketoi wind farm The Resource Management (Energy and Climate Change) Amendment Act 2004 specifically amended Section 7 RMA to require decision makers to have particular regard to the benefits associated with the use and development of renewable energy sources (section 7(j)) Section 104E regarding discharges of greenhouse gases requires consent authorities not to have regard to their effects on climate change, except to the extent that development and use of renewable energy enables a reduction of such discharges to air

These are all consistent with development of new renewable energy generation, such

as wind farms This legislative change is largely in response to concerns about energy security and greenhouse gas emissions, which are also reflected in a preference for renewable energy sources in recent pronouncements on government policy, as detailed below

The development of new renewable generation capacity, such as the proposed Puketoi wind farm, would contribute to government’s objectives of restraining greenhouse gas emissions and diversifying its mix of electricity generation away from the current dominance of hydro, which poses risks to the reliability and security of

supply during dry years Government policy towards renewable generation is included in such measures as the Emissions Trading Scheme, the Energy Strategy, and the National Policy Statement for Renewable Energy Generation under the RMA These are examined in section 3.3 below

The measure of economic value of Puketoi wind farm is its contribution to economic well-being in the community at large This includes the benefits it provides to producers of electricity, to consumers of electricity and to third parties, such as those facing the consequences it creates on the wider environment The scope of this benefit is national, not just confined to the local or regional economy, including:

• Creation of a valuable commodity from a naturally renewable resource;

• Displacement of higher cost thermal generation and associated emissions;

• Wider consequences for the electricity supply system and the availability of electricity to its consumers;

• Net effects on recreational and tourism opportunities and on local environmental amenity;

• Expenditure impacts from employment and purchases in the economy (more significant for the local/regional than the national economy)

2.2 Components of economic assessment

2.2.1 Components of cost benefit analysis of a wind farm

The focus on resource use efficiency in section 7(b) RMA is compatible with cost benefit analysis, so it is useful to view the effects in that framework Such analysis focuses on economic surpluses, the separable effects on consumers, producers and third parties (external effects), and the distinction between additional gains (benefits) and losses (costs) from available resources In the case of wind farms such as the Puketoi wind farm, the principal effects could include

• Effects on consumers:

− Benefit from lower cost power supply: some suppression of price rises can be expected to the extent the wind farm displaces or defers the need to use higher cost generation elsewhere;

− Benefit from avoidance of transmission losses due to closer generation to local demand centres – also with some downward price effect for consumers during periods when local demand exceeds supply and power would otherwise need

to be transmitted long distances;

− Benefit from reduced probability of supply disruption – a quality improvement in electricity supply to the extent that more diversified supply reduces the dry-year risk and improves security of supply;

• Effects on producers:

− Benefit from the value of output from the wind farm;

− Benefit from any synergies that may be realised between the wind farm and other generation such as hydro-power schemes (additional value from joint operation);

− Costs incurred in construction, operation and maintenance;

• Effects on third parties (environment):

− Cost of displacement of activities, if any (recreation, farming);

− Benefit of reduced greenhouse gas emissions from displacement of thermal electricity generation based on fossil fuels, to the extent this is not internalised into the producers’ cost of generation (as through an emissions trading scheme);

− Other environmental effects (cost or benefit to be determined)

The breadth of components in a cost benefit analysis means that it is best conducted from a national perspective, i.e the costs and benefits that matter are those that affect residents of New Zealand Thus, the consumer benefits of Puketoi wind farm are relevant whether they are felt in the wind farm’s vicinity or anywhere else within New Zealand

2.2.2 Components of economic impact analysis of a wind farm

An economic impact analysis has a narrower scope than a cost benefit analysis The elements of an impact analysis are:

• Direct impacts:

− Spending on construction in the wind farm development years, which may be measured as total expenditure on the project in the local economy, the new jobs created by the project, and the incomes retained from the project by suppliers of labour and materials;

− Spending on wind farm operations and maintenance in subsequent years, measured as total expenditure on the project in the local economy, the new jobs created by the project, and the incomes retained from the project by suppliers of labour and materials;

− Rental income generated by the project;

community level Put another way, the real resource effects of a new development are the increased value of output and the costs incurred, but rates and taxes are just

“claims” made to a share of the gain in net output

Because a project that is small on a national scale can be proportionately more significant for a local economy, such impact analysis lends itself to a more local or regional perspective rather than a national perspective However, not all spending is retained within the locality of the project Purchases of supplies from outside the region “leak out” of the region, an effect which is explicitly allowed for in the calculation of economic multipliers Moreover, some of the apparent impact may be business diversion rather than new business creation For example, jobs created would be an unambiguous indicator of benefit if all those newly employed were previously unemployed, but if they draw labour from other businesses in the locality there can be offsetting effects on the productivity in other sectors, at least temporarily This means that impact analyses have a tendency to overstate local net effects by an indeterminate amount

Because there is no comprehensive measure of how goods and services move across jurisdictional boundaries within New Zealand, and because of the way economic statistics are collected, economic indicators tend to be more complete and reliable at national level than at regional level, and more reliable at regional level than

at district level Discussion of local impacts in this report will refer primarily to impacts

on a proximate region consisting of Tararua District, Masterton District, Manawatu District and Palmerston North City, with implications on individual districts within the region where it is feasible to do so

3 The existing environment

3.1 Electricity supply and demand in New Zealand

New Zealand has a mix of hydro, thermal (predominantly gas and coal, but also some fuel oil, wood and diesel), geothermal, wind and biogas electricity generation capacity Most of the current generation capacity in the South Island is hydro, which

is reliant on precipitation and spring snow-melt, providing limited storage of water to spread generation over longer periods, and for much of the time generating in excess

of South Island demand thereby providing surplus for transmission to North Island demand centres The North Island has more mixed generation sources, with a cluster

of generation plant in Taranaki based on gas, hydro resources concentrated on the Waikato River, but also some located in the Bay of Plenty, Poverty Bay and Taranaki, geothermal plant located mostly on the Taupo Volcanic Zone and wind power generation in the Waikato, Manawatu and Wellington regions

In the 2009 calendar year, New Zealand’s total installed generation capacity was 9,486 MW, which generated (net) output of 42,010 GWh, 3.5% of which came from wind generation sources

Figure 1 Current generation across New Zealand

Year end December 2009

Installed capacity (MW) Net generation (GWh)

Source: Ministry of Economic Development (2010) New Zealand Energy Data

File From TAB_G.3b TAB_G.2a

As at November 2010, the Electricity Authority listed 106 MW of new generation capacity as under construction, 2,143 MW as consented, 1,355 MW as consent under appeal and 1,520 MW as applied for consent.1 Earliest commission dates

1

Electricity Authority (2010) Generation Update – November 2010,

http://www.ea.govt.nz/document/11979/download/industry/modelling/long-term-generation-development/list-of-generation-projects/

ranged between 2011 and 2020 Of this total new capacity, 58% would be wind powered and 11% hydro

There is no economically viable way to store electricity in bulk, except indirectly by storing water in hydro lakes or stockpiling other fuels Despite recent additions to generating capacity in the North Island, New Zealand remains a long thin country, in which major generation and storage capacity is in the South Island, but major load centres are concentrated in the North Island Imbalances between supply and demand within and between regions give rise to the need for transmission, which is achieved with a national grid that comprises high voltage Alternating Current (AC) transmission lines in each island, and the High Voltage Direct Current (HVDC) transmission link between the lower South Island at Benmore sub-station, and the Haywards sub-station just north of Wellington

The proposed Puketoi wind farm’s 53 turbines of 3 to 6.15 MW capacity each, would have installed capacity of 159 to 326 MW and be capable of generating 706 to 1272 GWh per year This is equivalent to adding 1.7% to 3.4% to New Zealand’s total installed generation capacity and 1.6% to 3.0% to current annual generation The

706 to 1272 GWh generation is based on a utilisation rate of about 44.5%, which is at the upper end of the range of utilisation rates achieved at other New Zealand wind sites The Puketoi site has an excellent wind resource, which is not surprising given its proximity to other sites in Manawatu’s northern Tararua Range which have already been developed for wind generation

3.1.1 Forecast growth in electricity demand

Between 1979 and 2009, New Zealand’s net generation grew from 22,175 GWh to 42,010 GWh.2 This almost doubling in electricity supply over 30 years is equivalent to

a compound growth rate of 2.2% per year Five year rolling average growth rates have declined since the 1980s, but rarely dropped below 1.5% per year until 2009 Over the long term, electricity consumption has moved in line with economic growth

In 2006, the Ministry of Economic Development published its electricity consumption forecasts to 2030 Those forecasts suggested growth over the period 2005 to 2030 of 1.3% per year, on average.3 An update of these outlook forecasts in 2010 indicated a lower rate of electricity consumption of 0.9% per year, considerably lower than the expected average annual economic growth of 2.3%.4 These forecasts attribute this change to improvements in energy efficiency and economic growth being concentrated in less energy intensive service industries Economic growth appears to have become decoupled from electricity growth

The Electricity Commission’s Statement of Opportunities (SOO) contains regional

and national projections of electricity consumption and prudent peak capacity

requirements, to assist in determining future transmission capacity requirements.5

The Electricity Commission’s latest projections suggested stronger growth in national

electricity demand than the MED’s outlook, by on average 1.8% per year over the

period 2009 to 2020 and 1.5% per year over the period 2009 to 2040 The prudent

peak capacity required to meet the peaks in demand associated with the above

average consumption growth was expected to grow at a higher rate of 1.7% per year

for New Zealand as a whole and 2.0% and 1.1% for the North Island and South

Island respectively

The Electricity Authority has updated these forecasts on its website These suggest

similar growth in consumption to the earlier SOO forecasts, but rather lower rates of

increasing provision of prudent peak capacity

Figure 2 Electricity consumption forecasts 2009-2025

Consumption volumes and compound annual growth rate

Residential Commercial & industrial Local lines losses Less embedded generation Total 

2009 1647 24137 14588 38725

(2) Total = Residential +Commercial & industrial + local lines loses – embedded generation

(3) CAGR: compound annual growth rate

Source: NZIER; Electricity Authority;

So forecast growth rates are low by historical standards, reflecting assumptions about energy efficiency improvements, but there are varied expectations of how low they could be Actual growth rates could be somewhat lower or higher than these forecasts In particular consumer behavioural responses to changes in price and reliability of electricity or new sources of demand (like household appliances and automation) make future demands inherently difficult to predict

3.1.2 Expected increase in generation capacity

New Zealand is expected to expand its generation capacity to meet this projected demand, and other reasons reinforce this expectation of capacity expansion

a) Dry years

Although New Zealand currently has sufficient generating capacity to meet electricity demand in most years, its reliance on hydro sources makes it vulnerable to sharp increases in wholesale prices in dry years when low hydro storage levels in the autumn and winter coincide with peak demand The effect can be seen in the prices received in the wholesale electricity market Figure 3 shows pronounced dry year price spikes in 2001, 2003, 2006 and 2008 in mean monthly wholesale prices at the Haywards node, a pattern repeated at other reference points across New Zealand

Figure 3 Mean monthly wholesale electricity prices

$/MWh, Haywards node, Jan 2000 to March 2011, mean

Source: Electricity Authority CDS

Providing additional wind generation can diversify the national electricity generation capacity and thereby time-shift the use of hydro to improve energy supply, especially for dry years This is due to both characteristics of two different types of generation

Hydro generation is driven by the weather pattern, and the system’s water storage level, whereas, wind has utilisation percentage - which is specific to site In general, though, more wind turbine capacity means more electricity produced during the year This is one function that Puketoi wind farm would fulfil

b) Gas supply uncertainties

As shown in Figure 1 above, after hydro, gas is the second most important source of electricity New Zealand faces uncertainty over the availability of gas for electricity generation in the medium term, due to depletion of the Maui gas field reserve, and also whether there will be timely new discoveries sufficient to replace this source, despite policies encouraging gas exploration

In 2008, gas production from Maui was just over 25% of the level it was at its peak in

2001 The Pohokura gas field surpassed Maui as the largest single source of gas for the first time in 2007 In 2008, it produced 41% of total output, Maui produced 30% and Kapuni 12%, with the remainder coming from seven other small gas fields

Contact Energy recently finished constructing a 200 MW open cycle gas turbine plant

at Stratford in Taranaki This is designed to be a peaking plant, operating most frequently at times of peak prices, and will have more modest annual fuel requirements than a base-load gas-fired plant There is unlikely to be much expansion in gas-fired base-load generation in the next few years, unless gas discoveries exceed current expectations.6 Other sources of electricity will need to expand as the contribution of gas declines

Internationally strong demand for energy from fast growing developing economies has placed upward pressure on fossil fuel prices for most of the past decade Figure

4 illustrates this for the 20 years to 2009, and while oil and gas prices dipped from their high points in 2009 they have since started rising again This increases the price

of fuel oil as a source of back-stop generation, and makes a wider range of renewable generation types more feasible

http://www.electricitycommission.govt.nz/opdev/modelling/information/gas-generation

Figure 4 Recent trends in fossil fuel prices

Representative internationally traded commodities

Crude Oil Natural Gas Coal

Natural gas in New Zealand has been historically insulated from these international trends because it has not been cost effective to export the gas;neither have there been imprted But as international prices rise, and technologies improve and come down in price, it becomes increasingly likely that New Zealand’s gas will become part

of the global market (liquefied petroleum gas or liquefied natural gas).As soon as this happens the local gas prices would move in line with international gas prices

Increasing renewable generation will minimise our exposure to these rising costs In particular, renewables like wind generation are not affected by fluctuations in fuel prices, unlike gas and coal generation, conferring a benefit in security of supply and suppressing price variation

c) Greenhouse gas emissions

A further reason for expanding specifically renewable generation capacity is the government’s ratification of the Kyoto Protocol in 2002 This created an incentive for New Zealand to reduce its greenhouse gas emissions, both to avoid the need to purchase entitlements for emissions above New Zealand’s allowance over the period

2007 to 2012 and, to provide an opportunity for New Zealand to sell any entitlements surplus to its needs to countries that exceed their emissions allowances

Although a successor agreement to the Kyoto Protocol has yet to be agreed, New Zealand is likely to be a signatory to any such agreement and to continue to face an incentive to reduce emissions The target that the government committed to at the

round of negotiations held in Copenhagen in December 2009 was that, subject to conditions, New Zealand reduce its emissions to between 10% and 20% below 1990 levels by 2020 The Kyoto Protocol commitment was to reduce emissions to the 1990 level

In July 2010 electricity generation became subject to the New Zealand Emissions Trading Scheme, which increases the costs of fuelling generation with gas and more particularly coal Over the last few years, the Huntly Power Station has produced between 3,000 GWh and 6,000 GWh of electricity per year, depending on hydrological conditions, providing additional base-load generation during winter or when hydro generators have chosen to store water for later use Much of this is coal fired generation Gas supply uncertainties in the medium term mean that these generators are unlikely to be converted to run on gas full time Expansion in other generation capacity is likely to be required as age and cost pressures make it likely the Huntly generators will be gradually retired over the next 10 to 15 years.7

d) Growth in demand

As discussed above, the demand for electricity continues to grow, even with improving energy efficiency, driven in large part by New Zealand’s growing population and economy Even modest demand growth of 1% per year on average over the next 10 years, assuming a 25% margin of potential output over consumption under normal hydrological conditions,8 would require generation capacity to expand

by approximately 525 GWh per year.9 If demand grew at 2% per year on average, generation capacity would need to expand by approximately 1,050 GWh per year

e) Total expansion requirements

Combining the requirement to replace retiring power plant and accommodate expected growth in demand suggests that over the next few years investment will be needed in additional generation capacity, especially from renewable sources Observed expansion over the period 1999 to 2008 averaged sufficient capacity to generate additional 974 GWh per year.10 Arguably this rate could increase in future to cover the substantial plant retirements in the medium term future Predictions of future generation needs generally assume no significant changes in technologies or consumer demand responses to changes in power prices, so precise forecasts are always open to debate

assume that between one (the coal scenario) and three (the sustainable and high gas scenarios) Huntly generators will be taken out of service at various dates between 2017 and 2025

8

Electricity Technical Advisory Group and Ministry of Economic Development (2009) Improving

Electricity Market Performance, Volume 2 - Appendices: Appendix 4 states that mean annual

margins have been in the range of 18-25% of annual output in the period since 1990

http://www.med.govt.nz/templates/MultipageDocumentTOC 41697.aspx

and 125% of this, in turn, is 525 GWh

Electricity Market Performance, Volume 2 – Appendices

However, the likely direction of future requirements is clear from population and economic growth, and adding new wind generation can contribute to meeting this need Currently there is a substantial capacity consented but not yet built and other capacity consented but under appeal While it might be questioned whether this overhang of unimplemented consents means less new generation is required, it is not inefficient to have more capacity consented than is actually built, to give firms options

to develop (or not develop) their portfolio of power plant according to when and where it is most efficient for them to do so

3.2 The role of wind in meeting electricity demand

Heavy reliance on hydro-generated electricity leaves New Zealand vulnerable to the effects of dry years, as was evident in public energy conservation campaigns in dry spells in 2001 and 2003 The risks of dry years are alleviated by developing alternative renewable generation plant, such as wind powered or geothermal plant The proposed Puketoi wind farm will be linked to the national transmission grid which will enable it to supply power to the wholesale electricity market, so the benefits of its additional generation are more national, than local, in scope Over 95% of electricity generated is dispatched via the grid, the balance being used on site by co-generation plant or generators embedded in local distribution systems

Since 1996 the buying and selling of wholesale electricity is done via a pooled market

in which generators offer to supply electricity and retailers bid to buy electricity at particular locations, at prices set for half-hour intervals The system operator, Transpower Ltd, has responsibility for ordering despatch from the stack of generator offers to match demand, and to do so using the sources that satisfy demand at the lowest overall cost after taking into account: expected transmission losses; the requirements for reserve generation; and the physical constraints on the capacity of the transmission grid at each location Unlike most other electricity markets in the world, the New Zealand wholesale market11 is designed so that the selection of generation plant to operate takes into account the expected transmission losses to meet demand from various sources

There are a number of important consequences that flow from the design of the wholesale electricity market:

• generators will take into account the economic consequences of transmission losses when making investment decisions about where to locate a generating plant; transmission losses are not externalities that need to be considered when assessing the public benefits and costs of proposals under RMA, as they will have been factored into the decisions of the applicant;

prepared for the Electricity Commission:

http://www.electricitycommission.govt.nz/pdfs/opdev/wholesale/market-design/Electricity-markets.pdf

• in the despatch process potential transmission losses and grid constraints are taken into account in determining which generators will operate so as to satisfy demand at minimum overall cost;

• generators facing competitors are incentivised to offer power at their short run marginal cost (SRMC), the efficient price, so as to maximise their likelihood of selection for despatch and enable selection of lowest cost generation for each despatch stack; and

• the price paid for all supply in each dispatch stack is set by the plant at the margin, i.e the one last selected with highest cost power So all other plant in the stack with lower SRMC earn a “producer surplus” that contributes to profit and to providing a return on the investment in the plant The ‘marginal’ plant is paid what

it offered but every other plant that generates is paid more than the price at which

it offered

Once built, wind farms have SRMCs close to zero, as their fuel (wind) is free and has

to be used when it is available, or otherwise lost, as there is no way of storing wind energy Hydro-electric schemes also have SRMCs close to zero when there is no need or capacity to store water for a later period

The rules of the wholesale market require that generators not alter their offers to generate into the market in the time period within two hours of the start of the half hour to which they relate If, for reasons beyond their control, a generator does have

to alter its offers within this two hour window then it is required to establish the change was due to circumstances which are acceptable according to the market rules

The imposition of a rule not allowing changes in offers from two hours prior to trading

on wind powered generators would be onerous or unworkable given their intermittent output To cater for wind, the market rules allow offers for wind generators to be varied within the two hour window and even during the half-hour trading period provided the variations in volumes of electricity offered have been derived in a

specified manner The quid pro quo for this concession is that the market rules

require wind generators to offer all their output at $0.01/MWh The intention behind this restriction is to preclude wind generators using their greater flexibility to game the market by using late alterations of volume offered to increase their likelihood of being dispatched for some output at high prices

As a result of the design of the wholesale electricity market, wind farms are likely to

be used to generate whenever they have sufficient wind and transmission capacity to

do so When they do run, they will generally displace higher short run marginal cost thermal plants Wind farms may also initially displace power from hydro-electricity schemes, but generally only when the value of the water in their dams is high because of dry conditions or the hydro plant faces transmission constraints that the wind farm does not Whenever a hydro-station offers at a price above its SRMC then

a wind farm will displace it

When conditions are dry is precisely when it is desirable to conserve stored water where this is possible Without wind farms, the usual replacement for hydro in dry conditions would be thermal capacity with higher short run marginal costs

Under the grid investment test (GIT)12, transmission constraints only continue if removal of them will not generate greater public benefits than the costs of removing them; if it would be an economically inefficient use of resources to remove them The addition of the low-priced wind generation may displace a hydro plant offering at

a high price because it has the capacity to store water and is setting its offers to reflect its view of the high opportunity cost of stored water (driven by the costs of fossil fuels) Analysis of market data shows that the ‘marginal’ plant in the sense of being the plant with the highest offer price dispatched is often a hydro plant, offering

at a price at or above that of thermal generation.13 In such situations, however, the eventual effect is still very likely to be that the wind generation displaces fossil fuel-fired generation In the first instance, wind displaces hydro but water storage also increases and eventually this stored water is used to displace fossil fuel-fired generation

The addition of wind generation will not generally knock a hydro plant which is gaming the market out of the dispatch stack either The owners of such plant will reshape their offers to take into account that the introduction of the wind plant means

an additional quantity of electricity will be offered to the market at $0.01/MWh rather than continue to offer as before and not be dispatched

With constraints faced by New Zealand’s two main generation sources, hydro and gas, wind power offers potential to provide additional generation capacity and diversify New Zealand’s energy sources It has the additional attraction of using a free renewable energy source with zero carbon emissions in operation Whether it is economically efficient to do so depends on wind generation displacing or deferring more costly sources of generation Decisions on building new generation capacity depends on the long run marginal cost (LRMC) of different generation, which includes provision for the capital cost of the facilities used

3.3 National objectives and policy for electricity

A preference for renewable energy sources, such as wind, has been expressed in recent government policy

12

Refer to 4.2.1 section for more information

scheme in the NZ electricity market”; LECG, Wellington