A review of the draft Waitaki Catchment plan Report to Major Electricity Users’ Group April 2005 Preface NZIER is a specialist consulting firm that uses applied economic research and analysis to provide a wide range of strategic advice to clients in the public and private sectors, throughout New Zealand and Australia, and further afield. NZIER is also known for its long-established Quarterly Survey of Business Opinion and Quarterly Predictions. Our aim is to be the premier centre of applied economic research in New Zealand. We pride ourselves on our reputation for independence and delivering quality analysis in the right form, and at the right time, for our clients. We ensure quality through teamwork on individual projects, critical review at internal seminars, and by peer review at various stages through a project by a senior staff member otherwise not involved in the project. NZIER was established in 1958. Authorship This report has been prepared at NZIER by Vhari McWha. The assistance of Brent Layton, Peter Clough and Simon Hope is gratefully acknowledged. 8 Halswell St, Thorndon P O Box 3479, Wellington Tel: +64 4 472 1880 Fax: +64 4 472 1211 [email protected] www.nzier.org.nz NZIER’s standard terms of engagement for contract research can be found at www.nzier.org.nz. While NZIER will use all reasonable endeavours in undertaking contract research and producing reports to ensure the information is as accurate as practicable, the Institute, its contributors, employees, and Board shall not be liable (whether in contract, tort (including negligence), equity or on any other basis) for any loss or damage sustained by any person relying on such work whatever the cause of such loss or damage. Executive Summary The Major Electricity Users’ Group has commissioned this report to highlight the key effects of the draft Waitaki Catchment Water Allocation Regional Plan on electricity generation and the wider economy. We have reviewed the plan in the context of economic efficiency, considering: • The impact of the draft plan on electricity generation, price and cost. • The impact of the draft plan on the wider electricity industry, principally in relation to security of supply. • (Briefly) the environmental justification for the draft plan. • The broader effects of the draft plan on the economy. • At a high level, what alternatives are available to the WAB. Key issues identified There are some key issues around the draft objectives of the plan. In particular, there is no protection of existing users or recognition of their rights. In the context of the Resource Management Act and ensuring investment incentives, this principle is fundamental. Second, the efficiency objectives are unnecessarily narrow and focused on technical efficiency (i.e. using the least input to achieve a specific output), rather than allocative and dynamic efficiency (i.e. choosing the highest value use over time). It is well established that dynamic efficiency goals are to be preferred over other types of efficiency (including static efficiency). Finally, in terms of the objectives, they are not measurable. Hence it is not possible to know whether the plan achieves them. In terms of the rules, there is some uncertainty about how some of the plan would be implemented. We have identified three key changes to the environmental flow and levels regime that would affect the electricity market and the economy more widely. These are: • A minimum flow of 3 cumecs down the Tekapo River. There is currently no minimum flow. • An increase in the minimum level of Lake Tekapo from 702.1m (above mean sea level) to 704.1m. • An increase in minimum flows downstream of the Waitaki Dam from 120 cumecs year round, to 200 cumecs in winter and 230 cumecs in summer. NZIER – A review of the draft Waitaki Catchment plan i We consider the impact of these changes using examples and estimating where possible the quantitative effect. • Electricity production from the Waitaki system will be 75GWh lower each year as a result of the minimum flow down the Tekapo River. • The profile of generation will be flatter due to minimum flow requirements. Generation in summer will be higher one third of the time on average than it otherwise would be. In winter storage will be dedicated to meeting river requirements. As a result electricity will not be available as flexibly to meet peak demand. • Generation will be redistributed from winter to summer as a result of lower storage. The likely longer-term impact of the WAB’s proposed regime would be to force investment in mid-merit or peaking capacity that would not be made if hydro-flexibility was maintained. If hydro-flexibility can be retained then new investment is more likely to be in higher efficiency baseload plant with lower short-run marginal cost (and higher capital cost). Prices are likely to rise. In the short term, prices are likely to rise more than in the longer term, as the market adjusts. In the longer term though, the use of more hydro in summer and less in winter will see average prices pushed up, as winter peaks are increasingly met from more expensive thermal plant. Another economic cost relates to higher levels of spill. Spill is a result of inflows exceeding outflows when lakes are full (i.e. no storage is available). With an increasing need for storage buffers to ensure the proposed inflows can be met, it is more likely that spill will occur. This is contrary to the Government Policy Statement on Electricity Governance which set an objective of using fuel resources efficiently, including minimising spill. A further detrimental effect is the loss of hydro-firming for wind generation. Wind and hydro generation are synergistic, because the short-term stability of hydro capacity can be used to off-set the short-term intermittent nature of wind. A corollary of this is that if the WAB’s draft recommendations are implemented, less hydro storage will be available as wind-firming capacity. This may in turn restrict the development of New Zealand’s wind resource. This would mean that other (presumably non-renewable) generation would be required to replace potential wind capacity. Security of supply will deteriorate. It is more likely that the level of the storage in the lakes will be insufficient to meet demand even with all thermal capacity operating. This means that existing reserve plant will be relied on more often, and additional reserve plant may be required. The restricted capability of the HVDC to transfer energy south exposes the South Island to significant risk if hydro assets are not optimised and reliance is placed on the provision of energy from the North Island. NZIER – A review of the draft Waitaki Catchment plan ii It is clear that the WAB draft rules will result in an increase in the cost of electricity generation and a greater risk to security of supply. The grounds, relating to adverse environmental impacts, for making these changes are not demonstrated in the plan. In Part V of the RMA there is an obligation to set out the principal reasons for objectives and policies in a regional plan, and to state the environmental results expected. Given the scale of the changes, and lack of any apparent justification for them, we recommend continuing the existing regime. Recommended amendments The key modifications we recommend to the draft plan are: • Including the recognition of existing users’ rights as an objective of the plan. • Developing, or providing for the development of, a regime that would allow transferability of rights using a market mechanism to ensure dynamic efficiency. • Amending the objectives so that they are measurable. • Maintaining the existing environmental flows and levels regime. NZIER – A review of the draft Waitaki Catchment plan iii Contents 1. Introduction .............................................................................................. 1 2. Key terms.................................................................................................. 1 3. Approach .................................................................................................. 2 4. The draft plan ........................................................................................... 2 4.1 Objectives .............................................................................................. 2 4.2 Rules...................................................................................................... 4 5. Electricity generation............................................................................... 5 5.1 Lake Tekapo storage ............................................................................. 5 5.2 Tekapo River flow .................................................................................. 6 5.3 Minimum flows ....................................................................................... 6 5.3.1 Interpretation ..................................................................................... 6 5.3.2 Illustrating the effect of the minimum flow regime.............................. 7 5.3.3 Dry year flow management – storage................................................ 8 5.3.4 Conclusion on effect of minimum flows ........................................... 10 5.4 Overview – effect of WAB draft plan on electricity generation.............. 11 6. Electricity prices and costs................................................................... 12 6.1 Costs of proposed regime.................................................................... 12 6.1.1 Generation investment costs..........................................................