The marketplace, created by poorly executed political strategies to deregulate New Zealand’s energy sector, has not solved the country’s energy supply and pricing problems. Nor does it look like solving them in future.
So now New Zealand’s energy companies believe we need more energy generating capacity to provide for increased future demand and to insure against “dry” years when southern hydro lake levels fall.
Before they build additional power stations however, they want adequate fuel supply and some guarantees from business. And given the myriad compliances, including the Resource Management Act (RMA) and other bureaucratic and non-regulatory hurdles (including commercial uncertainties) that led to the abandonment of Meridian Energy’s proposed 570 megawatt $1.2 billion Aqua power project, another large-scale hydro power scheme seems unlikely.
With the odds stacked against other hydro schemes materialising on our major rivers, all eyes are focused on alternatives. Maui, our largest gas field, has limited shelf life. There is some dispute about this but, based on current usage, that life could be as short as five years. Others claim we are bound to find more, but who knows? Coal, therefore, stands out as an obvious solution.
We’ve got stacks of it, enough to last several hundred years, but carbon credit taxes, courtesy of the Kyoto Protocol due to kick-in in 2008, will make this solid fuel significantly less competitive. Carbon taxes could add 1.5 cents per kilowatt-hour (kWh) to an average spot price of around six to seven cents per kilowatt-hour.
Electricity intensive
The energy squeeze is, on the face of it, only major headache for management in the big manufacturing firms like Comalco’s aluminium smelter or wood products giant Carter Holt Harvey. In these industries, electricity accounts for significant 20 percent plus of total operating costs. Around 20 or so electricity-intensive businesses between them consume around 20 to 30 percent of New Zealand’s total electricity.
Costs at Comalco’s Tiwai Point smelter climbed 50 percent over the past three years, and so electricity now represents 55 percent of the company’s operating costs. The company has abandoned any thoughts it may have had of expanding the smelter because of the uncertainty of both power price and supply.
Comalco buys 90 percent of its power from Meridian Energy under long-term contract which expires in 2012. It buys the rest on the spot market. The spike in electricity prices in March last year forced the company to drop production and stop buying power on the spot market. With output down by 14,000 tonnes, Comalco lost $33 million in revenue.
Smoking gun
Electricity price spikes might not wound smaller manufacturers like Ullrich Aluminium quite so severely but they still hurt the business enough for it to cut back on production, says CEO Gilbert Ullrich. “Spikes in the last two years have forced companies like us to cut back production. And to manage [the process] effectively requires juggling the price spikes between our two plants.”
The dilemma facing smaller manufacturers understates the danger of the smoking gun that could go off in the face of all businesses if our looming energy crisis is left unresolved. It is, obviously, both price and supply issue. Energy consultant Bryan Leyland says non-manufacturers who consider themselves immune to energy issues are “naïve”. So what have they failed to grasp?
Cuts looming
The three main hydro lakes are currently nearly full. The risks of power shortages this winter are, therefore, relatively low. But prevailing wisdom suggests that prolonged dry spell and some unusually cold weather, delivers 1:10 chance of power cuts before spring. Reserves have run down over the past five years. Leyland calculates that right now we need an extra 250 to 500 megawatts of power to return to where we should be to survive one-in-60-year dry spell.
Conventional wisdom also suggests that three percent economic growth translates to around two percent growth in electricity demand. The reality, according to experts like Leyland, is that our electricity supply has not kept pace with load growth of around 2.3 percent between 1999 and 2003. New Zealand used 40,000 gigawatt-hours (GWh) – that’s 40,000 million kilowatt-hours – of power last year. Best estimates expect electricity demand to grow by between 150 megawatts and 200 megawatts every year. If we can’t cope with existing demand, how will we cater for future economic growth?
Supply concerns
The direct impact on any business of uncertainty in energy supply and price is what catapults this otherwise rhetorical question squarely into all managers’ laps, says Leyland.
The impacts of shortages and high prices are unquestionably more visible at the top end where, for example, they threaten the future viability of companies like Comalco and CHH. But life further down the food-chain will be just as uncomfortable. The net effect of energy shortages on manufacturing translates to greater difficulty buying long-term hedges – to cover total electricity consumption – at reasonable prices. It might also force regular or irregular daily shut-down times. That’s because generators are only locking-in long-term contracts based on how much they can generate in dry year – the rest goes on the spot market.
Consequential loss
So in the sandpit where most companies play, the key concern is reliability of supply rather than price. National grid operator TransPower makes no secret of the fact that it believes the grid is running out of capacity. Maui’s predicted extinction in 2007 simply adds insult to injury.
As Auckland city firms who endured the infamous Mercury Energy power blackout six years ago well know, the cost of electricity is tiny compared with the consequential business impact of no electricity at all. Leyland puts the average value/price ratio at around 10:1, but says ratio of 100:1 would apply in many business situations. How much business can you do when key business processes, dependent on computers and telephones, are powerless?
Management’s approach
How, then, should management approach the current energy generation deficit?
Leyland thinks all managers should take long-term strategic approach to electricity, that is relative to both its contribution to total operating cost, and the life of any existing plant.
Given what has happened to prices in recent years management should, he says, make every effort to buy good hedges. Anything below eight to nine cents per kilowatt-hour is still regarded as pretty good price. Not surprisingly, energy generators like Mighty River and Genesis are reporting more interest from businesses wanting to take out long-term hedging contracts. So be in quick.
Leyland then recommends an efficiency audit to discover how power consumption can be reduced without affecting production. “Ask yourself what you can do to reduce electricity usage without causing the firm any real pain,” he suggests. “Replacing filament lamps with energy efficient ones is an obvious example.”
Management should then look hard at plant operations. That means working out what can be shut down quickly – that’s non-essential use – without it having serious impact on production. And have plan B ready for when electricity prices go up.
Finally, managers should identify which production processes can be shut down and do the least damage. And maybe consider hiring an emergency generator at 40 to 60 cents per kilowatt-hour.
Possible relocation
The big question facing some firms, says Ullrich, is whether to look for back-up alternative energy sources like diesel or even look for manufacturing sites offshore. With electricity costs already accounting for around $750,000 year, Ullrich is seriously contemplating diesel back-up for his Hamilton plant. He’s also thinking about relocating more production to his Newcastle (Australia) plant with its access to reliable supply of
