This article was first posted on 8 August 2024 for Infometrics clients.

The New Zealand energy market has been in the spotlight recently, as a shortfall of energy, from both gas and electricity, has sent energy prices soaring. It’s become such an issue that production has started to be curtailed for some operators, either because they cannot procure energy supplies, or it has become economically unviable to pay such high prices.

The energy challenge has become so bad, so fast, that Energy Minister Simeon Brown has publicly stated that the government is considering importing LNG to cover the shortfall.

What has now become a very real energy crisis comes after energy has been more in the headlines recently. Short-supply has already seen the grid operator, Transpower, issue national grid emergencies during periods of cold weather and generation outages. And then there’s the failure of a transmission tower carrying power to Northland, after the bolts on too many legs were unscrewed, which we estimate cost the Northland region around $60 million.

Faced with massively higher prices to power equipment to continue operating, producers are forced to rethink how they operate. In this analysis, we examine energy prices over recent years, the impact of the current gas shortage, and how producers are reacting.

Wholesale electricity prices have skyrocketed recently, to the point where electricity retailer Electric Kiwi have put a freeze on new customer registrations. Electric Kiwi stated, “current wholesale energy futures prices have now reached a point where every new customer would be loss making for our business”.

We are yet to see the extent of these difficult conditions flow through to many businesses due to the fixed price nature of standard electricity contracts. Electricity retailers also typically manage the volatility of wholesale electricity prices by hedging.

Part of the energy pricing pressure has come about due to low hydro lake storage, which means more expensive forms of generation are needed to cover the gap. Hydro storage dropped to 60% of the historic mean at the end of July due to a lack of rain over hydro catchment areas. This has been the greatest contributor to the monthly average wholesale electricity prices at Haywards reaching the highest level on record (going back to the 1990s) and 230% higher than a year ago.

Hydro-lake levels are important to forecast wholesale price, and depending on the hedge position of the retailer, these levels can influence the wholesale electricity portion of a consumers’ bill.

The current energy crisis is due to interconnecting trends, with a shortage of natural gas causing gas prices to rise (the logical economic response when supply of something becomes scarcer, but demand remains the same). That decrease in gas availability and increase in gas prices has pushed wholesale electricity prices higher, as wholesale electricity spot prices reflect the marginal cost of energy (at this point, that’s gas prices).

Not only are gas, and then electricity, prices high, but actual supply of gas to some businesses means that, even if they have a contract for gas to be supplied, they can’t access the gas they require.

Gas is important, both to the wider energy market but particularly for some production facilities. Gas made up 9.5% of total electricity generation over the year to March 2024 and is currently in scarcely short supply, with gas production forecast to fall below demand for each of the next three years. New Zealand relies on the local supply of gas to power many companies’ productions and for some household cooking and heating. The industrial sector used 61% of all gas used in New Zealand in 2023, illustrating the importance of gas in the production of key export commodities such as methanol, pulp, and paper products.

The exorbitant gas prices have forced many industrial producers to review their NZ operations, reduce operations or even temporarily shutdown.

• Methanex, the largest gas user in the country, is reviewing its New Zealand operations (based in Taranaki) due to gas prices forcing it to operate at less than half capacity.
• Winstone Pulp International has paused its operations at Karioi and Tangiwai mills in Ruapehu as it considers the future of the sites.
• Oji Fibre Solutions is proposing to close its Penrose mill in Auckland, after large and continued losses.
• Pan Pac’s Hawke’s Bay operations have seen a tripling in its gas costs, undermining profitability levels.

The gas shortage and low hydro storage levels driving wholesale electricity prices up have also led to some big electricity users being asked to reduce their usage.

Last month, electricity provider to Tiwai Point aluminium smelter, Meridian, triggered a provision in its supply contract requiring the smelter to reduce power usage, reducing the smelter’s capacity by around 25%. Although the demand response has stopped energy cost rises from being even larger, and limiting the risk that electricity supply outstripped demand, this demand response costs too – both in the value paid to the smelter to for not producing, and the lower than otherwise level of production and export possible. Given the smelter accounts for 13% of total energy demand, a more secure energy future would also provide greater certainty of its production.

Although the country has goals to continue to shift away from non-renewable electricity generation sources, they will remain a key part of our generation capacity and industrial production in the foreseeable future.

Variable weather conditions prevailed over recent years, highlighting the need for sufficient and widespread sources of energy. As previously mentioned, hydro storage was at 60% of the historic mean at the end of last month, whereas a year earlier, hydro storage was at 112% of the historic mean. As Chart 2 shows, geothermal, solar, and wind generation is rising in importance over time, but non-renewables remain a part of the mix.

If we’re currently suffering from a shortage of energy, relative to demand for energy, there’s two things you can do. Increase supply, or decrease demand. And demand is growing.

Short supply of hydro-generation and gas reserves provide uncertainty for the electricity system and for businesses. And they’re costing the economy.

Power shortages and outages cause uncertainty for businesses, loss of sales, and output for manufacturers. We are also forced to import coal to produce enough electricity to power the country, which goes against our renewable energy and emissions targets.

With electricity demand expected to increase rapidly, we need to continue investment generation infrastructure over the coming years. Demand is expected to be driven over time by the ongoing electrification of commercial heating and industrial processes, followed by continued uptake of EVs, development of data centres for AI, and population growth.

MBIE’s Electricity Demand and Generation Scenarios (see Chart 3) reinforce the need for gas supply and infrastructure in the future “to ensure enough firm capacity to reliably meet peak demand, new gas peakers are required to provide firming in all scenarios.”

We currently expect around $5.5b in electricity generation projects to be developed over the seven years to 2031. But much of that is frontloaded with projects already in the works, and uncertainty around the increase needed in generation means worries around the energy supply-demand balance might be here to stay for a while.

As new projects are (hopefully) commissioned, we’ll assess them and add that investment to our Infrastructure Pipeline Profile, which analyses all large-scale infrastructure projects and spending across New Zealand’s regions over the next ten years, including electricity transmission, distribution, and generation.