Comment

The ever-evolving challenge of electricity supply & demand

The events of Spring 2018 put a spotlight on the wholesale electricity market. James Stevenson-Wallace, Chief Executive of the Electricity Authority, says getting the balance of electricity supply and demand right is a complex task and one that is always evolving.

The New Zealand wholesale market has been around since 1996 and is regarded as having reached a relatively mature stage of development. Its purpose is to balance supply and demand, allow the right price to emerge and enable people to manage risk.

While the fundamentals are sound, it operates in an ever-evolving space—there are always more challenges. The Authority has a key role in helping the market address those challenges—for example the growth of electric transport, the installation of more batteries on to the system, or ensuring prices are sending the right signals.

Last Spring constrained gas supplies and low lake levels caused higher prices in the wholesale market, and some participants came under pressure. This led to some interesting discussions about aspects of the market design and operation.

Wholesale electricity prices since 1996, as a 30-day moving average of settled prices for all nodes. While prices in Spring 2018 were high, they also reached this level during a dry season in 2008. (Source: Electricity Authority)

The engine of the industry

Getting the balance of electricity supply and demand right is a complex task. Lots of decisions go into managing it every minute of every day—as households and businesses make choices about when, where and how much to consume, generate or invest. The wholesale electricity market is the engine coordinating this decision-making. It captures available information about costs, risks and opportunities, and processes it to create clear price signals.

It operates in a context where there are several sources of uncertainty (relative to other countries)—including 65 percent of our generation being weather-dependent, 20 percent being dependent on international fuel supplies, only being able to rely on domestic generation, and the technical challenges of having to move electricity long distances.

The wholesale market has three main components: alongside the spot market where generators must sell and retailers must buy, there are two other markets: the forward contracts market and the ancillary services market that generates prices for special technical services ensuring reliable and quality supply.

Market design allows evolution

The wholesale market design helps the industry operate efficiently through change—by clearly signalling what response is valued and facilitating competition to explore opportunities. In guiding the development path, we seek to maintain and build confidence in the market, and support investment in the electricity sector.

Increasingly, electricity might be supplied by solar PV, batteries and wind generation. These kinds of technologies may be more variable in output, as well as being owned and controlled by a multitude of investors rather than a few centralised ones. Also, other new technologies will give consumers more choice and greater control over their electricity use. These factors potentially create new risks and opportunities that will require different management approaches and expectations of the wholesale market.

Furthermore, climate change concerns and policies, and major technology changes such as uptake of electric vehicles and solar PV, may mean change happens at a much faster pace.

To be effective, the prices produced by the wholesale market need to be a certain and accurate reflection of the costs, risks and opportunities – as these evolve. This is why we regard high prices at times of genuine scarcity as an effective and necessary signal to the market for short-term usage and generation decisions, and long-term investment.

Manage through uncertainty

Key to this is ensuring participants can manage through periods of volatility. Availability of good information, understanding the risks and using the forward contract market enable them to do this.

The forward contracts market, for example, allows participants to lock in a price well in advance. All kinds of people with different information and views of future spot prices can participate. This gives a collective view of what prices will be in the coming month through to the next three years or more. It also provides a way for participants to manage costs associated with potential spot price volatility, according to their risk appetite. This is driven by their own business strategy.

Refining the market design

Our current and future work programme is shaped by our principled approach to market design, the market context and any problems and enhancement opportunities we identify.

We monitor market performance to make sure it is operating in a way consistent with a well-functioning and disciplined market. Sometimes a specific event will cause us to review aspects of the design.

We also actively monitor market behaviour and will enforce compliance with the rules to ensure parties are discouraged from abusing market power. We apply a risk-based framework, which is well practised across government and gives us the ability to calibrate our approach to the prevailing industry environment. To underpin ongoing confidence in the market, we need to take a deliberate and hardline approach to compliance and enforcement.  

Occasionally, it’s necessary for us to change the rules. For example, we’re taking a second look at the trading conduct rules to improve clarity.

One area of focus is the development of financial risk management tools. For example in 2013 we launched the Financial Transmission Rights (FTRs) market to help generators and retailers manage the price risk that exists across different geographical points. Losses and constraints on the transmission network cause a price difference  the risk is very much like the exchange rate risk for importers and exporters.

Initial success of this market meant the Authority increased the number of FTR hubs from two in 2013 to eight now. Over time the FTR manager has been able to increase the volume of FTRs available.

The amount of transmission price risk covered by Financial Transmission Rights (FTRs) each year since this market was launched in 2013. (Source: ftr.co.nz)

Also, the participants have broadened from generators, large industrial users and retailers, to include proprietary traders who use this product to be more active and support liquidity in the Australian Securities Exchange (ASX) options market. As a result of this increasing competition, the auction prices for FTRs have moved closer to a more cost-efficient level, that is, better reflecting the network costs involved.

We recognise there are always opportunities for us to improve the market design and operation, and we encourage feedback about where we should act.

The full-length version of this commentary is available on the Authority’s website in the form of a 6-page paper. James Stevenson-Wallace will speak at Downstream Energy Market Conference in Auckland, which runs from Tuesday 5 March

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