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Water, wind and kilowatts

Background

New Zealand's electricity industry is divided into four key sectors, namely, generation, high voltage transmission, distribution and retail. The main generators are also retailers in the various distribution network areas. Transmission lines are owned by the state-owned enterprise, Transpower, while the distribution network is owned by various companies and trusts.

The electricity industry has gone through a number of reforms since the late 1980s. These are listed chronologically in the final section of this article.

New Zealand's electricity generation comes from a number of sources. The main source is hydro power, which is a renewable energy source largely unaffected by the increasing cost of fossil fuels. However, hydro power supply is reliant on adequate water levels in storage lakes. Approximately 60 percent of electricity comes from hydro, with the balance from geothermal, gas, coal and oil-fired thermal stations, bio-mass plants and wind farms.

The relative importance of hydro power and other sources have changed over the years with the increasing demand for electricity. Twenty years ago, hydro power accounted for more than 70 percent of the total electricity generated. As the population and the economy have grown, hydro power's share has declined to approximately 60 percent of total electricity generated today.

Over the past two decades, from the year to March 1987 to March 2007, electricity generation rose by a total of 42.6 percent (an annual growth rate of 1.8 percent). Over the same period, the population and economy (as measured by gross domestic product at constant prices) grew by totals of 26.6 percent and 61.2 percent, respectively (giving annual growth rates of 1.2 percent and 2.4 percent, respectively). This growing demand has resulted in an increasing reliance on other sources to make up for the limited hydro supply. Because hydro supply is dependent on sufficient rainfall, snowmelt and adequate water levels in the storage lakes, dry seasons and periods of high demand sometimes result in periods of tight electricity supply.

Figure 1

Graph, Electricity Generation by Fuel Type.

Changes in the electricity market structure, growing demand and vulnerability to weather conditions are factors that have influenced electricity prices over time. This article focuses on how electricity prices have tracked since 1994, when a separate producers price index (PPI) for electricity generation and supply became available. It examines electricity generation and supply, which shows the change in prices received for the output produced by firms in the electricity sectors (from generation to retailing) and it also reviews the change in prices faced by households for the consumption of electricity based on the consumers price index (CPI) for electricity.

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Electricity generation and supply

The PPI for electricity generation and supply consists of two types: the outputs index (series reference: PPIQ.SUD01), which measures change in the prices received by producers (that is, by generators, transmitters, distributors and retailers of electricity); and the inputs index (series reference: PPIQ.SND01), which measures change in the costs of production of producers excluding labour and capital costs. This part of the article focuses on the outputs index, although there are references to items related to electricity production because these can affect the electricity prices producers charge to customers.

The relative importance of generation, transmission, distribution and retail prices in the PPI electricity generation and supply outputs index are shown in the following table:

Sectror Expenditure weight (March 2006 quarter),
percent
Generation (1) 23.00
Transmission 7.08
Distribution 18.45
Retail – non domestic 29.02
Retail – domestic 22.45
Total 100.00

(1) Change in generation prices is measured after settlement of hedged contracts

Figure 2 shows the PPI all industries outputs index and the PPI electricity generation and supply outputs index from the June 1994 quarter to the June 2007 quarter. During this period, the PPI outputs index had an overall increase of 31.7 percent while the electricity generation and supply index increased by 57.7 percent. Electricity generation and supply prices fluctuated considerably from the June 1999 quarter to the June 2007 quarter. This variability can largely be attributed to the wholesale electricity market structure.

Figure 2

Graph, Producers Price Index - Outputs.

During the five-year period from the June 1994 quarter to the June 1999 quarter, electricity generation and supply prices were generally stable. Government owned and controlled almost all of the electricity generation under the corporatised department Electricity Corporation of New Zealand (ECNZ). In February 1996, ECNZ was split into ECNZ and Contact Energy and the wholesale electricity market commenced in October 1996.

In April 1999, ECNZ was further split into three separate companies (Mighty River Power, Genesis Power and Meridian Energy). That same month, the industry also launched a profiling system that enabled consumers to switch electricity retailers more easily. Fluctuations in prices began in the September 1999 quarter when prices for electricity generation and supply started to fall. Prices decreased for five consecutive quarters with a total decline of 7.9 percent from the June 1999 quarter to the September 2000 quarter. Factors that influenced this were the increased number of generators and higher-than-average hydro lake storage levels in some quarters.

Prices began to rise in 2001 and have cyclically fluctuated since then. The wholesale electricity spot prices became increasingly responsive to the changes in hydro lake storage levels. Figure 3, which includes hydro storage information supplied by M-co and NIWA, illustrates this effect.

Figure 3

Graph, Hydro Lake Storage Levels and PPI Electricity Generation and Supply Outputs.

The winters of 2001 and 2003 and persistent dry weather conditions in 2005 until early 2006 resulted in lower-than-average hydro storage lake levels. Lower lake levels and the demand for electricity caused wholesale electricity spot market prices to increase during these periods. The price increases were:

  • 29.4 percent from the September 2000 quarter to the March 2002 quarter
  • 35.6 percent from the December 2002 quarter to the December 2003 quarter
  • 39.1 percent from the September 2004 quarter to the March 2006 quarter.

Conversely, the improved inflows to the hydro lakes have at times resulted in lower electricity prices in the wholesale market. This was particularly evident in early 2004, when hydro lake storage levels were well above average. The falls in electricity prices were:

  • 13.6 percent from the March 2002 quarter to the December 2002 quarter
  • 18.7 percent from the December 2003 quarter to the September 2004 quarter
  • 13.8 percent from the March 2006 quarter to the March 2007 quarter.

Although the hydro lake levels have had a cyclical influence on prices since 2000, there has been an increasing trend in electricity generation and supply prices by a total of 61.3 percent from the June 2000 quarter to the June 2007 quarter.

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Electricity consumption

From the consumers’ perspective, price changes are more controlled and stable in terms of fluctuations because retailers sell electricity to households at fixed prices (despite changes in wholesale market prices) and prices are reviewed only periodically.

The CPI and the CPI electricity price index graph (series reference: CPIQ.SEP04501) in figure 4 shows how prices changed over time for household consumers from the June 1994 quarter until the June 2007 quarter.

Figure 4

Graph, Consumers Price Index All Groups and Electricity.

Over the 12-year period from the June 1994 quarter to the June 2007 quarter, the CPI increased overall by 34.0 percent while electricity prices for household consumers increased by 79.8 percent.

From the start of the series until the end of 2001, electricity prices for household consumers rose at a slightly higher rate than the overall CPI. Electricity prices for household consumers increased by a total of 20.8 percent while the CPI rose by a total of 16.4 percent from the June 1994 quarter to the December 2001 quarter.

Electricity prices for household consumers were flat for the September 1999 and the December 1999 quarters because they included estimates of the effect of households shifting to competing retailers. The emergence of competing retailers led to changes in the methods of calculation for the CPI electricity price index, beginning in the March 2000 quarter. This was previously calculated based on a single tariff option and one electricity use level from one retailer in each line company area surveyed for the CPI. It included prompt payment discounts. From the March 2000 quarter, calculation was changed to a wider range of tariff options and three levels of use (low, medium and high); it also reflected the relative importance of the incumbent retailer and competing retailers for each of the 15 urban areas surveyed for the CPI. Further details about how the CPI electricity price index is compiled can be found in the April 2007 issue of Price Index News (see How electricity price changes are measured in the CPI)

Electricity prices remained stable during the winter supply shortage from July to September 2001. Retail prices for households are only reviewed periodically so there can be a lag before changes in generation and supply prices are reflected in the prices paid by consumers.

A steeper upward trend in prices began in early 2002. Electricity prices for household consumers increased by a total of 48.8 percent from the December 2001 quarter to the June 2007 quarter (an annual growth rate of 7.5 percent), compared with a total of 15.1 percent for the overall CPI. As noted above, electricity generation and supply prices increased by 61.3 percent from the June 2000 quarter to the June 2007 quarter.

Another development that may have slightly influenced the increase of electricity prices for household consumers over this period would be the construction of reserve generation capacity. In 2003, the Electricity Commission contracted with generators to build reserve generation capacity that would help ensure electricity supply for dry years. The costs were to be recovered by means of a levy on all wholesale purchases, which electricity retailers, consequently, pass on to consumers.

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The history of electricity reform

Below are important events that took place in the electricity sector that may have contributed directly and indirectly to electricity market prices.

  • Prior to 1987: Government controlled and operated almost all New Zealand electricity generation and transmission.
  • 1987: Electricity generation was deregulated. Electricity Corporation of New Zealand (ECNZ) was set up to own and operate the generation and transmission of electricity.
  • 1988: Transpower was set-up to run the transmission network as a subsidiary of ECNZ.
  • 1993: Electricity Market Company (now M-co) was established as a joint venture by New Zealand electricity industry players to act as a focal point for the design of a wholesale electricity market.
  • 1994: Transpower was separated from ECNZ and established as a stand-alone state-owned enterprise.
  • 1995: The Government made provisional announcements on the steps it would take in the lead up to the opening of the wholesale electricity market, including splitting ECNZ into two state-owned enterprises (ECNZ and Contact Energy).
  • 1996: Contact Energy commenced operations as an electricity generator in competition with ECNZ. The wholesale electricity market also began trading operations under the New Zealand Electricity Market (NZEM).
  • 1998: The Government passed the Electricity Industry Reform Act, separating ownership of line companies from electricity generation and retail businesses.
  • 1999: Contact Energy was privatised and ECNZ was split into three separate companies: Mighty River Power, Genesis Power and Meridian Energy. A system for customer switching was also established allowing consumers to choose their electricity retailer.
  • 2000: A Government Policy Statement was released requiring the electricity sector to establish a new electricity governance board.
  • 2001: The Electricity Industry Bill was enacted, empowering the Commerce Commission to regulate line charges.
  • 2003: An industry referendum on self-governance failed and Government established a new industry regulator – the Electricity Commission. The Government announced plans to build a new power plant for security of electricity supply under the management of the Electricity Commission. Decisions on price, quality and profit thresholds for electricity lines businesses were also released by the Commerce Commission.
  • 2004: The Electricity Commission took over responsibility for operating the electricity market. A 155-megawatt reserve generation plant was commissioned. The price path threshold of "CPI-X" was implemented by the Commerce Commission to apply to lines businesses where X represents the expected annual reduction in lines business average prices based on their productivity and profitability performance.

Back to Price Index News: October 2007

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