As part of its five part consultation on advancing New Zealand’s Energy Strategy, the Ministry of Business, Innovation and Employment (MBIE) has released an issues paper seeking feedback on a wide range of challenges and opportunities facing New Zealand as it seeks to manage the transition to an expanded and more highly renewable electricity system (Issues Paper).

The Issues Paper also looks at how this can be achieved in the context of ensuring that the system remains affordable, reliable and resilient.

In this third article in our series, we take a look at the main issues MBIE is consulting on, and what you need to know.

The consultation will investigate and obtain feedback on the challenges, priorities and Government support measures required to enable an affordable and reliable electricity system, being one of the actions that the Government committed to under the Emissions Reduction Plan (see our legal update on the Emissions Reduction Plan for more details).

While the consultation will be relevant to a wide variety of participants across the electricity sectors, it presents many open questions rather than proposed solutions. We expect feedback on the consultation will be taken into account by MBIE in preparing the Energy Strategy for release in 2024, but it is clear that electricity system measures are still in the early stages of policy development.

Simpson Grierson is providing analysis on all five consultation documents, available (when published) on our website, see the links at the bottom of this page.

The Issues Paper at a glance

For each of the 5 main aspects of the electricity system being consulted on, the Issues Paper sets out the main issues and challenges, summarises the current range of Government initiatives and developments (both planned and underway), aims to identify gaps where further or alternative measures could be needed (including overseas comparisons) and seeks feedback on the challenges and priorities.

We set out a summary and provide our thoughts on the most interesting and relevant aspects below.

1. Growing renewable generation

The Government is consulting on how to ensure sufficient new generation is developed to meet increased demand (68% by 2050) from an electrified economy, and replace the role of fossil fuel generation, while ensuring the security and reliability of the electricity system (with a projected cost of around $42 billion).

The Issues Paper acknowledges a number of factors that may be slowing development of sufficient new renewable generation in New Zealand, including:

• regulation (government policy) and demand side uncertainties;
• managing investment risks, including price risk for investors in baseload renewable generation;
• obtaining resource consents under the Natural and Built Environment Act 2023;
• offshore wind regulatory processes;
• consent requirements under the Overseas Investment Act 2005; and
• supply chain and skills availability issues.

These issues will be familiar to market participants and their advisers. We note that these factors are also broadly similar in other jurisdictions, but with specific differences for each local market particularly in respect of regulatory frameworks and local market conditions.

Financial support measures for price risks
The Government is considering a range of support measures for new renewable generation, having reviewed the types of support offered in other overseas markets. Key examples of this support that are being considered include financial support mechanisms such as contracts for difference, feed-in tariffs, renewable certificate obligations and (involvement as a purchaser under) power purchase agreements (PPAs).

The possible support measures need to be considered in the context of New Zealand market-specific factors, including its comparatively high level of renewable electricity generation, the impact of our Emissions Trading Scheme, and the more limited availability of electricity hedge products than larger markets like Australia and the UK.

We see financial support for price risks as perhaps the most important focus area for Government to consider, given its potential to efficiently unlock significant investment in new renewable generation projects. In particular, fostering a healthy PPA market in New Zealand is a critical element of ensuring a pipeline of bankable projects and an attractive investment environment. Given the Government’s appropriate but ambitious emissions reduction targets, our view is that market forces alone will be unlikely to deliver the level of investment required to build enough renewable generation to meet those targets and significant support will be needed (as has been the case in other comparable jurisdictions).

Firming capacity
Currently, fossil fuel plants are critical to ensuring firming generation capacity when intermittent (solar and wind) generation is unavailable and hydro generation is low. The Issues Paper considers the benefits of introducing a capacity market or similar scheme in New Zealand for the purpose of addressing a lack of firm capacity during the transition. It is noted that globally capacity markets have a mixed record in terms of operational success. Australia’s proposed capacity investment scheme is identified as a potential measure for incentivising the addition of storage to energy projects (such as battery energy storage systems combined with solar and wind projects).

If a capacity market was introduced in New Zealand, this would likely have the effect of rapidly increasing deployment of grid-scale batteries, which at this stage have not been a significant feature of our market (with a few notable exceptions). The role of this type of large-scale flexibility is also considered in relation to industrial users, who could also provide demand response flexibility back to the market to provide firming and reduce peak demand.

The role of gas peaking plant during the transition is also considered in this context, given its role in providing sufficient firmed generation. The Government has suggested that gas generation may be needed to maintain reliability and affordability while the electricity system expands, as fossil fuel plant closures without adequate replacement may lead to higher security of supply risks. See our legal update on the Gas Transition Plan Issues Paper for more details, link below.

Other considerations
A retailer reliability obligation (RRO) measure is examined by MBIE in the Issues Paper. This would involve a central agency (eg Transpower) forecasting demand and requiring retailers to obtain a quantity of capacity certificates based on their anticipated load. For example, in Australia AEMO has the ability to trigger this requirement by applying to the Australian Energy Regulator, with relevant entities required to hold net contract positions for the forecasted reliability gap period.

2. Competitive markets

The Government is consulting on whether there are potential competition issues within the electricity system that may arise during the transition, particularly in dispatchable renewable generation (hydro with storage for firm capacity), with reference to the Electricity Authority’s wholesale market review findings and the price discovery report released by the Market Development Advisory Group (MDAG).

As fossil fuel generation facilities retire, other forms of firm, flexible generation may become increasingly valuable (such as stored hydro generation, or any new pumped hydro generation once built). The Issues Paper observes that this evolving generation mix might have the effect of lessening competition for flexible generation, and asks whether support is required in the form of conduct or structural measures.

MDAG’s preferred options for maintaining or strengthening competition are to focus on a range of conduct measures, which include increasing transparency and enhancing conduct rules of the hedge market and introducing market-making for a shaped hedge product which would create better forward price discovery and market liquidity for flexibility services.

In terms of structural measures, it was noted that vertical separation between generation and retail businesses would not address the primary competition issue for the wholesale market, but both MDAG and the EA have recognised that integration has the potential to limit liquidity in the contracts (such as PPAs and hedge contracts) that are needed to manage price risk. The EA is investigating whether this market power is affecting retail competition, as recommended by the 2018-19 Electricity Price Review. The EA is also looking to monitor retail gross margins following analysis in 2022, which showed that cost breakdowns of gentailers and retailers without a generation portfolio were similar (potentially suggesting a competitive market).

The Issues Paper asks if structural changes to the market should be looked at now to address competition issues, in case they are urgently needed where conduct measures are proven to be inadequate. This includes consideration of both vertical (generation from retail) and horizontal (geographic footprint) separation measures.

In order for New Zealand to develop achieve its emissions reduction targets, in our view the Government will most likely need to provide significant support measures for offtake revenue from new generation projects. The current market for long-term PPAs is very limited, meaning that fewer projects have secure revenue streams necessary for obtaining the necessary debt finance. This lack of bankable projects is a key contributor to the lack of investment in new generation, and longer term could create higher electricity prices for New Zealand businesses and consumers.

3. Networks for the future

The Issues Paper asks how we can ensure sufficient transmission and distribution investment to support a larger share of renewable electricity generation, and whether current regulatory settings and objectives are fit for purpose or if regulators (ie the Electricity Authority, Commerce Commission and Energy Efficiency and Conservation Authority) would benefit from additional policy direction from Government. This includes considering how to secure sufficient investment and focus on the transmission system and distribution assets, whether current cost allocation models for connections are appropriate, whether renewable energy zones are needed and whether current regulatory objectives are too rigid for current policy priorities.

A transmission system for growth
For transmission, the Government notes the rapid increase in connection enquiries (348 as at July 2023), and Transpower has estimated that it will need around 80-85 new connections and similar network investments by 2035. Transmission assets currently take 7-10 years for Transpower to build. These factors could create significant delays and transmission constraints, stalling the deployment of new renewable capacity. The Issues Paper asks whether the balance of risks between investing too late and too early in transmission may have changed, compared to historical norms. In our view, if New Zealand is serious about meeting its climate goals, then the pace and scale of transmission investment must increase significantly.

Transpower is currently preparing its 5-year expenditure plan for 2025-2030, which will propose a significant increase in transmission grid investment. It has also recently submitted a major capital proposal to the Commerce Commission for around $400 million to enhance the core national grid. All such investments over $20 million require Commerce Commission approval, which involves applying prescribed investment test criteria. This regulatory process is being reviewed by the Commerce Commission, and MBIE notes that this is the correct vehicle for considering whether that process is still fit for purpose.  

Improving grid resilience is also noted as a key factor, given climate-related extreme weather events which are challenging electricity system infrastructure (such as Cyclone Gabrielle’s impact on the Hawkes’ Bay region). It is also observed that this investment can be costly, and can impact affordability of electricity for consumers. The Issues Paper asks whether any additional actions are need to ensure sufficient focus and investment in maintaining a resilient national grid.

Distribution networks for growth
With estimates of $22 billion being required for distribution investment in the 2020s, local lines networks will experience an unprecedented period of activity as they come under demand pressure for physical lines and poles as well as monitoring, data and systems management upgrades.

The Issues Paper identifies the biggest issues facing lines companies as the regulatory environment, barriers to connection for new demand, cost allocation to support anticipatory network investment, and lack of price signals to provide efficient use of networks. The key questions raised are whether new measures should be looked at to resolve these issues, how they should be prioritised, and whether the regulatory issues raised by lines companies are real barriers to efficient network investment.

The Issues Paper also canvasses barriers to new connections for critical decarbonisation projects, including EV charger rollout, hydrogen production and process heat electrification. The capital costs, connection process and lack of visibility on distribution network capacity are all identified as having the potential to create delays and complexities for these projects. The Issues Paper asks whether lines companies’ charges are unnecessarily high, how Government can deliver cost solutions, whether applying the pricing principles in Part 6 of the Electricity Industry Participation Code might assist, what challenges exist relating to connecting DER, and if there are different cost allocation models that should be explored for addressing first mover disadvantage when connecting to distribution networks. We note that the Transpower Pricing Methodology provides 2 solutions relating to transmission cost sharing that could be considered and potentially adapted for use in relation to distribution costs.

Sustainability objectives
The Issues Paper reviews the current statutory objectives for energy system regulators, and asks whether these are fit for purpose or too rigid given the Government’s policy priorities for decarbonisation and emissions reductions. MBIE asks whether a Government policy statement may need to be issued to regulators, and whether a lack of express climate change or emissions reduction objectives is a barrier to the energy transition. In our view, there is merit in clear policy direction to regulators given the scale of regulatory action needed to meet emissions targets, and this would likely have the additional benefit of sending positive investment signals to the capital markets.

4. Responsive demand and smarter systems

The Issues Paper considers how to maximise the opportunities arising from an increase in distributed energy resources (ie rooftop solar and batteries for homes and businesses), and how the Government can utilise smarter systems to improve reliability, resilience, supply security and affordability.

There are a number of issues and opportunities arising from distributed energy resources, which include rooftop solar and batteries near homes and businesses as well as other forms of smaller generation connected directly to their usage points (such as EV chargers and small to medium scale wind and solar farms). While there has been increasing uptake of this “distributed flexibility” in our electricity system, it is still comparatively low compared to the potential opportunity. Distributed flexibility is important for minimising the cost of transition, unlocking a “smart system” that offers increased system reliability, resilience, security of supply and affordability. It is estimated that this type of “smart system” could save $10 billion in costs required for the transition by 2050.

There are a number of challenges in developing New Zealand’s flexibility market, as well as in other overseas markets. One of the key challenges is that flexibility, such as ancillary services or network services, is difficult to capture revenue streams from without a viable marketplace. This is a major challenge for the transition.

The Issues Paper asks whether Government should set out the future structure of a common digital energy infrastructure, to allow trading of distributed flexibility, and whether it should see how innovation unfolds to help inform how trading of flexibility evolves in our market before providing any policy direction. Given significant interest in the New Zealand market on both supply and demand sides for grid scale batteries, for example, we expect the Government will need to take a pro-active approach to developing our flexibility markets in order to capture this opportunity.

Unsurprisingly, solar PV coupled with batteries is singled out for particular support in increasing distributed flexibility. Uptake of rooftop solar is low compared with Australia, where nearly a third of all households have solar energy systems. One key reason for the disparity is highly likely to be the levels of (regulated) subsidies and incentives offered to Australian households, particularly via feed-in tariffs, as compared with no such subsidies or incentives in New Zealand. The Issues Paper asks whether Government should consider ways to create more investment certainty for local battery storage, and whether upfront money should be made accessible to all households for battery storage (which is much more expensive than installing solar panels without a battery). In our view, support of distributed flexibility will be a key part of ensuring New Zealand meets its emissions reduction goals, and we look forward to seeing similar levels of uptake as in Australia. We also see an opportunity for more New Zealand businesses to adopt solar and battery systems, in line with recent global trends, as part of the push towards net zero.

5. Whole of system considerations

The Government is seeking feedback on what measures may assist in order to prioritise support measures across the entire electricity system, noting that a number of such measures are likely to be required using finite Government funding and resources.

Unlike in other jurisdictions, the system operator’s role in New Zealand does not include setting a roadmap for the relevant region or country. The Government asks if there are co-ordination or decision-making gaps, and what participants would like to see in this area.

Renewable energy zones (REZs) and their deployment in NZ are considered by the Issues Paper, along with a comparative approach that analyses the New South Wales REZs forming part of that State’s renewable energy roadmap. The New South Wales REZs are paid for by a consumer levy, on the basis that timely investment in reliable new generation will deliver lower electricity prices over time. It is noted that a REZ planning model does not easily fit within NZ’s system settings of competition in the generation market, and open access to the transmission network. The Issues Paper asks if there are significant advantages in adopting a REZ model or central planning model to co-ordinate investment, and whether this would effectively address the “first mover disadvantage” of having to arrange the initial connection to a distribution network. We note that Transpower’s REZ consultation concluded on 8 April 2022 however no outcomes have yet been released.

The Issues Paper asks if MBIE should publish opportunities for generation investment to enable more informed market decision-making (as recommended by the Electricity Authority), and the Government has said that there is merit in this proposal. Other information-sharing policy options are also being considered, for the purpose of supporting more active co-ordination of information inputs across the electricity market.

Balancing the energy trilemma (energy security, energy equity, environmental sustainability of energy systems) is carefully considered, and reference is made to a number of work streams across government that aim to address these challenges (notably, development of the Government’s Equitable Transitions Strategy).

Submissions

MBIE is currently developing the New Zealand Energy Strategy, which is due for release by the end of 2024. Responses that are submitted to the questions in each of the consultation papers will be considered by MBIE as part of that process.

Submissions on the consultation close on 2 November 2023, with full details and documents available at MBIE’s website.

If you wish to discuss any of the issues or opportunities arising from MBIE’s consultation on our future electricity system, or would like assistance in developing submissions, please contact any of our experts.

Simpson Grierson Energy System Consultation Series:

MBIE consults on New Zealand's Energy system #1: Gas Transition Plan Issues Paper

MBIE consults on New Zealand’s energy system #2: Interim Hydrogen Roadmap

MBIE consults on New Zealand’s energy system #4: Developing a Regulatory Framework for Offshore Renewable Energy

MBIE consults on New Zealand's energy system #5: Base ban on gas fired baseload generation