Wednesday, October 21, 2009

What now for Huntly?

There is some media attention on the recent financial performance of Genesis Energy and the write down of the Huntly Power Station in particular. There are a few issues that arise from this.

First, don't get carried away with accounting jiggery pokery. The Huntly write down is not a real cost. All the write down means is that one inaccurate estimate of Huntly's value has been replaced by another inaccurate estimate of Huntly's value; and the estimates are different.

Second, and far more importantly is the debate about the ongoing role of Huntly in the future. Genesis have a problem. They know, as do most reasonable people in the industry, that Huntly is a major contributor to security of energy supply in New Zealand. The problem is that there isn't a current mechanism by which the costs of keeping Huntly running will, necessarily, be recovered over time. This doesn't mean that Huntly isn't economic, it just means that the owner of Huntly may have to swallow signficant costs for those rare times that the station can earn large amounts of money (such as when hydro systems are experiencing severe droughts). For an owner of such an asset it is attractive to try to socialise at least some of the costs to keep the power station running. So, to an extent, it looks like Genesis may be playing a political game in its latest annual report and media release.

Nevertheless, it is worth considering whether there is a common good role for plant such as Huntly; and, therefore, whether there should be another mechanism for earning revenue. Somewhat ironically Huntly may have a major role to play in enabling renewables.

Renewable energy in significant quantities, in the foreseeable future, is likely to come from geothermal and wind. Geothermal has a limited beneficial contribution to the security of energy supply. When it is first commissioned geothermal almost certainly allows for more surplus of hydro-electricity but, on average, will be substantially matched to demand growth. This means that generally we will still have exposure to dry year risk as geothermal power stations will not be able to produce more (as they generally operate at maximum output) during these times.

Wind makes things worse (from an energy security basis) because it can only operate when the wind blows which may not always be when it is needed. Many proponents of wind suggest that wind and hydro are complimentary. Generally this is probably true but not at the extremes. Unfortunately you cannot guarantee that the wind will blow when you are in the middle of a drought. Indeed this was a problem during the drought of 2008. If New Zealand aspires to significant quantities of wind energy (with the associated economic and environmental benefits) then we will also need a large source of entirely discretionary generation on standby. This is an almost perfect description of the old Huntly power station - a large source of entirely discretionary generation on standby.

I'm not sure if Genesis are playing a political game or not but, regardless of the merits of such an approach, the ongoing role of Huntly needs to be elevated in the energy policy debate. And, ironically, it should be the greens that champion the old girl.

Monday, October 19, 2009

Businesses operate in the real world

I have quite a problem with the latest press release from EECA.

For the avoidance of doubt I am not criticising EECA's objectives, intent nor the value of what they are trying to achieve. My problem is that idealogical arguments are not, in and of themselves, useful in isolation of all the real world complexity of running a business.

The EECA media release implies that energy consumption does not constitute a supply in the same way as other supplies. Even more bizarre is the way that they conducted the survey behind the media release. Energy management was added as a category in its own right compared to such categories as customer and supplier relationships, competitiveness and profitability. Energy management is a component of these major categories not a category in its own right. Telecommunications management would be a legitimate major category under this system. No-one can be surprised that Energy Management scored the lowest of all of these categories as it is a subset of some of them. No subset can be more important than the superset it is from. Actually, Energy Management scored extremely high in this context.

EECA go on to make a vexatious argument, based on the global benefits of energy saving, that each business should pursue energy efficiency. The global benefits for energy saving may be very large but clearly, at the level of each business, the benefits are small. Such is the nature of a tragedy of the commons [1], although its not actually that clear that such a tragedy exists in this case. It seems to me that EECA are implying that businesses are not acting in their own best interests. This will not be true. Business, in aggregate, will be responding correctly to their incentives.

To be fair to EECA they face an unenviable task. They are tasked with very challenging targets for energy efficiency with little in the way of real resources or policy levers. Nevertheless, ideology, by itself, will usually be ineffective. If ideology is effective, in isolation, it can also be very dangerous. There are always externalities and practicalities that must be taken account of.

Notes [1] a tragedy of the commons exists when all individuals would benefit from cooperating in saving a resource but only if everyone cooperates. Usually, without a coordinating body or external interference, there is no cooperation because an individual can benefit from consuming first and fast.

Sunday, October 18, 2009

Is energy important?

I have just realised that I may be under a misconception. Judging from the occasional flurry of debate on power projects, and my own personal biases, I thought that the energy subject was an important one. But, maybe I am wrong.

I try to review the press in New Zealand to understand what the energy issues might be. This sometimes proves to be very difficult. Most times nobody seems to be very interested in energy. My recollection is that energy used to be its own subject area in newspapers but is no longer. I know there used to be a Ministry of Energy (now there is a Minister but no Ministry).

It seems that the debate about energy has become the more sophisticated debate about the environment. I find that a little surprising. I don't find it surprising that the environment would be a special subject of interest but that it replaces energy as a subject. To my mind the debate about energy and the environment is fundamentally about physical reality. The rules around the provision are inherently physical. Both the influences and the reality of environmental impacts are also inherently physical. A balanced debate about energy and the environment must surely be a discussion about physical reality and well considered trade offs between both.

I have already made posts on this blog to the effect that some of the debate around energy is ignoring physical realitites (let alone economic ones). Interestingly enough, in my opinion, the environmental debate also seems to be highly abstracted from reality. To an extent this is because the major concern in global environmental terms is highly complex and sufficiently indirect to be, for all practical purposes, abstract. Much of the solution infrastructure, global greenhouse gas markets, is also highly complex and abstract.

All of this belies the underlying reality that the problem is essentially physical and that there is no perfect solution. Ultimately, as well, there are no global solutions and that it is at the local level that each carefully considered trade off needs to be made. And, it is at the local level that the global abstractions become the most acute. In my previous post I posited that most people want windpower but most people would also rather that it isn't built near them.

My primary concern with the abstraction of the arguments is that these global abstractions do ignore the reality. That each solution must be both physically practical with acceptable physical effects at the local level. Unless these physical realities are well understood at the local level then the globally abstracted debate is meaningless.

What forum, is my question, is the local reality discussed in a policy sense? The RMA discusses local isssues but this is always from a purely local perspective. National's proposed EPA may achieve this purpose but if New Zealand's EPA becomes anything like Australia's then it will not reconcile local reality to global abstraction. It will only make the gap more layered in inaccessible bureaucracy.

Monday, October 12, 2009

Wind Energy - Doctor Jekyll and Mr Hide

Wind energy's fortunes in New Zealand continue to be mixed. Most people's attitude to wind tends to be similar. Most people would say that wind power is a good thing but most would also say "don't build one anywhere near me!"

One of winds problems is that there tends to be a belief that a windfarm can be built just anywhere and that energy companies are just being difficult in wanting to build them where locals don't want them. The problem is that windfarms need to be built where it is windy. Of course lots of places are windy but being occasionally windy isn't good enough. A place has to be fairly constantly windy and this isn't as common as most people think.

New Zealand has such windy places. Places where it blows strongly regularly. New Zealand is a good place to build windfarms but not just anywhere. For example, very few windfarms look feasible in the upper North Island. Locations that can be very windy, such as round the Kaipara and Manakau harbours, don't tend to be consistently windy and no windfarm in this region yet looks economic.

Alternatively the Manawatu region blows not just a lot but often. In fact the problem in some of the Manawatu ranges is almost that it is too windy. Wind turbines are mechanical devices and can be overloaded. Most Manawatu windfarms require the highest specification turbines available to withstand the mechanical stresses. However, this adds relatively little cost (or input energy) to sites that can produce a lot of wind energy.

A big issue in the Manawatu ranges is not that windfarms here have been blocked but that there are now so many of them. Local residents have a reasonable point to make in that adding more and more windfarms to the skyline does make a difference. And, as more of the remote sites are developed, the newest project proposals must, necesarily, be closer to existing residents and amenities. The residents of Palmerston North and its environs might feel somewhat aggrieved that they are bearing considerable brunt for the development of New Zealand's energy future. They aren't alone, however, the Waikato, Waitaki and Clutha Rivers have been irrevocably altered and give more energy each than the Manawatu yet does. The Bay of Plenty region is also being heavily developed, although with geothermal plant which has less obvious local impact. Manawatu's main issue isn't that development hasn't been concentrated in a region before but that windfarm developments are so obvious.

Many might argue that small scale generation is the future and they could be right. However, there are currently three significant barriers to this:

  1. There are economies of scale
  2. Small scale generation still needs to be built where the resources are significant (a small wind generator in a place where it isn't windy may never recover the energy it took to manufacture and construct)
  3. The electrical networks have significant technical challenges before signficant small scale distributed generation can be safely and economically exported.

What are we to do? In the absence of fossil fuel use (which would currently need to be imported unless New Zealand makes a big commitment to coal) then the major development opportunities for large scale energy use are wind and geothermal. Both are practically limited relying on technology to deliver more developable areas. If wind is a major component of New Zealand's energy future, which makes sense, then someone has to put up with them. And if we are to make the most of the resource with the smallest overall disruption and least input resources then they need to be built where it is windy, consistently windy.

Thursday, October 8, 2009

Ask a question about energy in New Zealand

What do you want to know about energy in New Zealand? Ask a question through the comment link below.

Monday, October 5, 2009

What is the problem with retail competition in electricity?

I don't think anyone really knows.

There have been a number of studies into the electricity industry in New Zealand but none that I am aware of have really analysed the retail market. There have been a few that have purported to, such as Wolak, but his study was really a wholesale market study (with flaws). The linkages he made to the retail market were somewhat nebulous and completely about correlation without any attempt to discuss causation.

The most comprehensive study that I have seen about the retail market in New Zealand was done by the Electricity Commission in their Market Design Review.

This review did some interesting analysis around the retail market. While this was some of the most in depth analysis that had been done on the retail market it actually lead to asking more questions than it answered. Particularly interesting of the ECs analysis was Figure 27 of chapter 2 page 28. These four charts demonstrate something quite strange. When it comes to large or high density networks (which New Zealand doesn't have many of) there appears to be a correlation between size and low retail margins (which is what you would expect with economies of scale). However, in small networks retail margin is random. Small networks can have very low retail margins, very high retail margins and everything in between. The reason for this is not clear.

Much public debate has been made of location and transmission constraints in preventing retail competition but, again, the evidence is correlation only (with no empirical analysis on causation) and is inconsistent. While generator-retailer operations do tend to be distributed around geographic areas, which can be explained by locationally restricted competition but can also be explained by the starting position of the generator-retailers and relatively low effective rates of switching. In other words correlation does not necessarily mean causation. More interestingly the concentration of generation does not line up with the margin uplift. Areas where there is significant regional generation (and therefore low location risk such as the central North Island) have networks with relatively high margins. Correspondingly, many of the small networks with low retail margins are remote from significant generation and should be expensive (if location risk is the real problem).

I don't know what the answer is but I do know that just about every review that has been done looks almost exclusively at the wholesale market. The wholesale market has been done to death, the New Zealand wholesale electricity market has been constantly reviewed and there is mountains of international literature on wholesale electricity markets. It is the retail market that needs a proper empirical review. The retail market is not an adjunct to the wholesale market. The retail market relies on the wholesale market for its input prices but in every other respect it is a different market with a different design and structure. It needs its own focus.

Sunday, October 4, 2009

Why nodal pricing matters for generation and transmission?

This is another follow up post to Brian Fallow's articale in the New Zealand Herald on asset swaps. One of the things he suggests in the article is that nodal pricing doesn't matter for generation. This is not true. Arguments about the relevance of nodal pricing to the demand side are quite valid.

Nodal pricing in fact is highly relevant to efficient generation and transmission outcomes both in operational terms and investment efficiency. The locational issue relevant to generation is the fundamental question, (at its simplest) are we better to have a local generator only or a remote generator with transmission? If you don't have a locational signal in your pricing then you run the risk of using a remote generator every time and having an increasingly expensive transmission network. This is true of operating the electricity system as well. Sending power through transmission lines heats those lines up, which represents a loss of energy to the system. Without a nodal pricing system for dispatch then you could easily use a far away generator to meet demand even though it uses proportionally more energy (through losses) than the difference in cost of the local generator. Choosing which plant should run to meet the energy needs at least cost overall is a process called economic dispatch.

Brian Fallow makes a reasonable point in suggesting that nodal prices are meaningless because renewables are the first cab off the rank for investment and they have to be built where there is a resource. This oversimplifies the issue, however, because there are lots of renewable projects and they are distributed all over the country. The question isn't so much where should a project be built (it must be built where fuel is available - this is even true of thermals) but which projects should be built. Given that the main logistic challenge of the power system is getting power to Auckland from all over the country (but with significant other loads at very different places - such as 12% of the country's demand at the very bottom of the South Island) then deciding the least cost way of moving this energy around is a complex problem. The SPD model is the piece of technical magic that performs this task. Then, managing to signal to potential investors where they should invest (nodal pricing) is a neat trick that falls out of the New Zealand's electricity market pricing model (SPD - which is in fact an economic dispatch model).

Even under the heading of renewables you can choose hydro in the South Island (and other places), geothermal in the central North Island or wind (predominantly around the lower North and upper South Island). Each choice has a markedly different impact on how much the grid will cost to dispatch and how much transmission capacity will need to be built; and this can be very different at different times depending on weather (hydro and wind), outages and fossil fuel stockpiles. The pricing model for generation and transmission is, necessarily, complex.

Most of the solutions proposed to increase simplicity tend to be quite static. This is to say that they might work well if the electricity system didn't change much. The problems with electricity supply, however, are either very short term (I have to meet demand now) or very long term (which 40 year investment decision is best). Neither of these suits static solutions. The electricity system is very dynamic and dynamic means complex.

This does contribute complexity to the buying side of electricity and it is here that pure nodal pricing and economic dispatch has far less relevance. Here some form of simplification might make sense.

Mr Fallow has made some sensible observations but he does need to be aware of one of Albert Einstein's most useful quotes: "Everything should be made as simple as possible, but not simpler."

Thursday, October 1, 2009

Does electricity have to be complicated?

Brian Fallow wrote a fairly good article in the NZ Herald yesterday.

In it he drew on the problems of asset swaps and some of the reasons why they might not work. He also wondered whether the complexity of the electricity market might be part of the problem; and, therefore, simplification could be part of the solution.

To an extent he has a point and there is some merit in pursuing some of his ideas. However, the reason that the electricity market is complicated is because electricity is complicated. While we should try to make things as simple as we reasonably can over-simplifying things that are genuinely complex can lead to a new set of problems.

But why is electricity so complicated?
Mr Fallow wonders whether things have been made complicated by engineers and economists. Again, to an extent, he has a point. The nodal market not only has nodal pricing but is also marginally priced including marginal transmission losses (and this is only the start of the gobbledegook). On the whole though the electricity system is more complicated than people realise and there are two good reasons for this.

First, electricity has its own branch of physics and much of the electricity system is constrained by pure physics. Electrical physics, in practice, probably isn't much more difficult than say the physics of flowing water, but is much less intuitively obvious. Most people, without necessarily understanding the underlying mathematical models can nevertheless understand that water falls down hill and will go anywhere lower than it is now if it isn't held back. A water system is fairly intuitive; and so too is a mechanical system. Electricity, though, does not behave in an intuitive way because it cannot be directly observed (for all practical purposes). For many people it is a mystery and it does have its peculiarities.

Second, electricity cannot be stored in large commercial quantities and must therefore be produced, transported and consumed at exactly the same time. This doesn't sound like a complicating factor but it is. If anyone has tried their hand at logistics, perhaps an example even as simple as buying, wrapping and posting Christmas presents so that they arrive at their destinations at the correct time, will know that logistics can be difficult at the best of times. Now imagine that the complexity of the problem is more like trying to coordinate traffic on all of Auckland's roads so that everything runs smoothly every second of every minute of every day of every year. The electricity system effectively does this and is does it in such a way that, generally, renewable resources are maximised and thermal fuel is called on as necessary. It also caters well for most emergencies of which there are many. And, it does so in such a way that new investment in the system does not need to be subsidised by the taxpayer.

Can the electricity market be simplified? Yes. Can it be simple? No, it cannot.