Another eventful year for the five large electricity generators in New Zealand

According to PwC’s latest edition of Leading Energy, an analysis of key issues and challenges facing New Zealand’s electricity generation and retail companies, recommendations from the Ministerial Review of Electricity Market Performance continue to impact the electricity market. Key recommendations progressed during the year included the sale of Meridian Energy’s Tekapo hydro generation assets to Genesis Energy, and the signing of the virtual asset swaps between the Stated Owned Enterprise (SOE) generators.

PwC Consulting Partner Mr Chris Taylor says “furthermore, the recommendation to establish a contestable fund for promoting consumer switching (also recommended under the Review), coupled with the rebalancing of retail and generation portfolios has resulted in record levels of customer churn.”

Other recommendations arising from the review are progressing and at various stage of consultation, including improving hedge market liquidity, scarcity pricing, improving demand-side market participation, and standardising line company tariff structures and use of system agreements.

The sector also experienced a significant pricing event on 26 March 2011 when an undesirable trading situation (UTS) was declared by the Electricity Authority (EA) as a result of events that occurred in the Hamilton area and north. Although initial prices have been reset by the EA, the EA’s decision is currently subject to appeal by several parties.

The Government also kick-started its extension of the mixed ownership model, with the appointment of advisors to undertake preparatory work, advise the Crown and undertake scoping studies of the three SOE generation companies.

Overall sector performance

Mr Taylor points out “demand for electricity has been somewhat stagnant during the last 12 months due to economic conditions, warmer temperatures and the impact of the Christchurch earthquakes. When coupled with a relatively high level of reserve capacity in the generation market, this has dampened wholesale electricity prices.”

While electricity revenues across the five major generators were largely unchanged from the prior year, earnings before interest, tax, depreciation, amortisation and financial instruments (EBITDAF) increased by 6%. Renewable sources continue to increase their share of generation volumes, with the proportion of renewable electricity generated by the five large generators, reaching 79% during FY11, up from 75% in FY10. Primarily this has been achieved on the back of more favourable hydrology (meaning higher hydro production) and the continued growth in geothermal generation capacity.

“Wind generation also increased. The continued influence of wind and other variable generation sources will continue to increase volatility in electricity prices, underpinning further investment in peaker plants to capture peak prices,” adds Mr Taylor.

Wholesale and trading

While the retail sector is experiencing high levels of customer churn and developing new products and offerings, the wholesale and trading divisions are also operating in an environment of new products and a much more dynamic market. “Not only are wholesale prices becoming more volatile but new commodities and trading instruments need to be managed,” says Mr Taylor.

The ASX futures market has been adopted by the major generators as a key mechanism, to assist in the development of a liquid hedge market. This has required a change in how these businesses manage their hedge portfolios, using an exchange traded, centrally cleared, standardised product. The major generators have been tasked with increasing volumes offered in this market, and improving the pricing of these futures contracts, to provide more transparent and robust forward pricing signals. In the event that the EA considers that insufficient progress has been made in this regard, it can consider further options for developing an active hedge market.

In addition to futures contracts, further derivative contracts are likely to be developed and listed on the ASX market, such as options and caps.

Financial transmission rights which allow parties to cover price risk between two nodes on the national grid are also in development and a market for FTRs is expected to be in operation from late 2012.

The recent review by an independent panel of the Emissions Trading Scheme gives rise to some uncertainty as to the amount of credits that electricity companies may be required to surrender in future, and the possible exclusion of certain carbon credits for meeting New Zealand obligations.

Mr Taylor says “these changes will provide both challenges and opportunities for electricity generator and retailer companies. More volatile prices will need to be managed, the use of ASX futures contracts will need to increase, more complex derivatives will be developed to manage price exposures (including FTRs), and the quantum and pricing of carbon credits remains uncertain.

“These changes and increasing complexity in the number and type of derivative products will provide a challenge to wholesale and trading businesses. In many cases the people, processes, systems and procedures required to manage these products, do not currently exist. Additionally, financial reporting and disclosures related to these derivatives and commodities will need consideration. These areas will need to be a priority area of focus for these businesses.”