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In Summary

Energy pricing is not just about volatility due to the Russian invasion of Ukraine. The fundamentals have been contributing to a firming electricity price future for quite some time. This backgrounder highlights some of the key factors involved.

The current New Zealand electricity market environment

The current market continues to support a belief in a systemic left in energy pricing.

  1. Spot electricity pricing has increased materially over the last five
  2. The ASX electricity futures market has lifted in later years, as well as near
  3. There is a growing realisation that thermal fuels will continue to play an important firming role in the supply of electricity in New Zealand, especially as the system manages the variability of hydro inflows and wind generation.
  4. Thermal fuels contain a carbon cost. Carbon has had a 150% increase in pricing in just over two years. On top of carbon costs, the underlying fuel costs for thermal fuels are on a rising
  5. When they are used, thermal stations tend to set the wholesale market
  6. Incumbents will be reluctant to allow an overbuild of renewable electricity, likely to collapse the market, because they would take write-downs on their existing

The current electricity spot market environment

  1. The forecast for the spot is expressed as a futures contract. These are traded on the ASX  futures market for New Zealand electricity.1 
  1. We have seen a sustained and systemic lift in pricing across multiple years now,  alongside periods of sustained price spikes. 2 
  1. Generation balances, which indicates the ability of generation to meet demand, are  expected to tighten in the near term.3

    1 https://www.asxenergy.com.au/futures_nz
    2 https://www.emi.ea.govt.nz/Forward%20markets/Reports
    3 https://nzgb.redspider.co.nz/

Central North Island Monthly Average Spot Market price 

The current electricity futures market environment

11. A systemic lift in pricing throughout the forward curve, with the Otahuhu Baseload
Future for the 2025 calendar year now trading at 12.5c/kWh with earlier years
significantly higher.4
12. On recent years there has been a theme for distant years to trade to near year levels
as time advances.

Last Four Years Otahuhu Calendar Year Baseload Electricity Futures 

The new hydro normal?

13. Inflows have recently been dependent upon short bursts of intense rainfall.5
14. Until renewables are overbuilt, the market will rely on thermal to firm the supply to
meet demand.

Recent Hydro inflows – North and South Islands

The gas market current market environment

  1. The gas industry has experienced recent field declines.6 though there have been  several promising workovers, such as at Maui, that are likely to improve supply in the medium term. 
  1. New supplies will be at an unknown cost, as the gas industry consolidates around incumbents due to the offshore exploration ban.

17. Gas market pricing appears to have reached a recent low and now sits at about $12/GJ or the equivalent of about $120/MWh.7 

EmsTradepoint Recent Gas Pricing

  1. At an emission factor of 0.48kg CO2-e/kWh, the carbon component of our gas price is now at $3.95/GJ , increasing the cost of electricity from gas by an additional 4-5c/kWh. 
  1. When gas is needed to meet the marginal supply of electricity, prices can be expected to be close to 22c/kWh after accounting for other direct costs and the cost of capital

The current carbon market environment

  1. The heat is on in the ETS and many participants now need to purchase units through the ETS auctions run by the EPA. 
  1. The latest results in March 2022 cleared at the trigger price of $70/t CO2-e.8
  2. Carbon has had a 150% increase in pricing in just over two years and now sits around $70/t CO2-e.9 
  1. This adds significant costs to the cost of electricity when thermals set the price.
  1. There has been a sustained run up in international coal pricing over the last five years, sustaining US$250/tonne last year prior to the recent Ukraine-related spike.10 International Coal Price
  1. At a price of US$250/tonne (NZ$385/tonne) and a conversion factor of 8MWh per tonne and a heat rate of 35%, fuel alone adds 14.3c/kWh to the cost of coal electricity. 
  1. With an emission factor of 0.92kg CO2-e/kWh, the carbon cost of coal is 6-7c/kWh. 
  2. When coal is needed to meet the marginal supply of electricity, prices can be  expected to be close to 25c/kWh after accounting for other direct costs and the cost of capital. Overall our electricity is getting dirtier  
  1. A combination of sporadic inflows, no overbuild of renewables (which is against incumbents’ interests as it would likely lead to significant asset write-downs, and a tightening gas supply market has meant that we have increasingly relied on dirtier coal over the last 5 years to balance our market.11 
  1. Whilst we have increased renewable energy as a proportion of supply, we have actually decreased emission-free electricity because the big increase in geothermal supply has still come with a GHG emissions profile.

How can solar help fix the problem?

  1. Firstly, solar has no emissions whilst it generates. 
  2. Lifetime emissions are negative. 
  3. Solar is reliable, the sun comes up every day at predictable times and we have reliable seasonable and daily production curves from NIWA. 
  1. Intermittency due to cloud cover is small relative to for example wind or hydro inflow volatility. 
  1. Solar reliability enables our hydro-generated electricity to be kept in storage for  longer until it is needed. 
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