Market guard rails

The Govt has launched an electricity market review. What blind spots do the cognitive guard rails create and what are the implications for the market?

Cognitive guard rails.

We live in a world of hyper specialization where the spectrum of our individual skill sets, and expertise is increasingly narrow. We focus more on the trees and much less on the forest.

As such we are increasingly suspectable to marketing slogans that shape narratives by romanticizing and oversimplifying complex ideas.

The underlying fundamental assumptions are ignored. Don’t worry about the pesky details, we are smart and will come up for a solution to those they say.

So, instead of questioning the assumptions we defer to the “experts” and hold in the forefront of our minds the glossy upbeat narrative of the marketing campaign.

These narratives set up subconscious cognitive guard rails directing the flow of thought in a circular manner that always arrives back at a central pre-determined idea. An idea that is taken for granted and is not sufficiently challenged.

The energy system debate is no different. Particularly in New Zealand where we are ideologically constrained to two central ideas.

1. The primary selection criteria for all energy sources, is that they must be renewable.

2. The market will solve all problems.

These cognitive guard rails drive us down a pathway that completely skips over the far more important questions of:

1. What is the specification required of our energy system in order to power a modern society, with the lowest environmental impact and to avoid economic collapse?

2. Is a market the most effective way to deliver this specification?

Electricity market review:

The fall out of last winter’s wholesale electricity shocks culminated in the Government commissioning a review of the electricity market.

On the 11th of Feb it was announced that an offshore consultancy Frontier Economics will lead this review.

This is what Energy Minister Simon Watts (good name for an Energy Minister) had to say about it.

“Energy security is a top priority for the Coalition Government as the economy electrifies and we work to double New Zealand’s renewable electricity generation. We expect to see market-led approaches to energy security throughout the transition, and we want to make sure the markets are performing effectively.

“This review will help ensure our regulatory settings can deliver on the long-term interests of consumers, keep prices down for Kiwis and keep the lights on.”

“From the review’s inception, we were clear that we needed experts capable of bringing a fresh perspective to the complex challenges facing our markets. Those chosen are well-qualified with significant expertise in international electricity market design, risk management, competition policy and financial instruments.”

As expected, the review skips over the fundamental questions of specification and the appropriateness of a market.

Instead, the review is set up on the unchallenged assumption that the market just needs a bit of tweaking and that anything with the “renewable” badge on it we want much more of.

Market headwinds.

Much is made of the rich wind resources in New Zealand. As Infrastructure Minister Chris Bishop describes it "We are the Saudi Arabia of renewable energy and so we need to take advantage of that." That’s a big claim, but politicians as we know are quite fond of hyperbole. Bishop is exaggerating with reference to Saudi Arabia but is correct that there is a lot of wind in New Zealand.

When we stay within the cognitive guard rails of it “must be renewable” and “the market will solve all problems”, it makes a lot of sense to assume that the best pathway to energy security for New Zealand is to expand our wind generation.

By subconsciously and fully embracing the wind industry marketing narrative which is firmly planted at forefront of the nation’s minds, we can imagine power companies buying or leasing windy sites across the country to build wind turbines on and then plugging then into the grid.

Deploying wind is relatively fast and incrementally scalable making it appear viable from the perspective of the capital required for relatively small electricity companies to enter the market. For example, the 43MWp Kaiwera downs wind farm featuring 10 turbines cost the relatively small amount of NZD $115 million to develop.

Sounds easy right?

It then stands to reason that there should be lots of players in the market and plenty of competition, especially with NZ wholesale electricity prices consistently being so high and a killing to be made.

So why then is the market not performing?

Physics & Complexity

Harnessing the energy of the wind at scale is hard. A reliable electricity grid is foundational to a modern society. Physics will always be the ultimate arbiter of any attempt to couple an intermittent energy source at scale to a grid that requires supply and demand to be perfectly matched in real time.

The wind is an incredible source of energy when you consider the sheer scale of it, however it is also incredibly dispersed. Which essentially means it is very widely spread but in low concentrations. In other words, it has low energy density.

Wind appears simple but like all low energy density and intermittent energy sources of energy it quickly becomes very complex to deploy at scale for several reasons.

• The iron law of energy density determines that low energy density = high resource intensity. What this means is that it takes a lot of infrastructure and land to capture wind energy. The infrastructure requires maintenance and has a relatively short life span. An individual turbine does not have a lot of output as such we always need a lot of them. They must be widely spaced to ensure that they do not cause a wake effect that will reduce the efficiency of adjacent turbines.

• The speed at which wind turbines rotate is variable which means that they need additional equipment, typically electronics, to allow them to be coupled to the grid at the 50hz frequency required. This not only adds complexity, but it can also result in the loss of grid inertia (momentum) in response to changes in load on the grid. A lack of inertia, or rotating momentum, can cause sudden frequency dips when the load increases quickly. This is a dangerous situation for the grid and worsens as the % of wind increases in the generation network. Frequency variability is already a challenge to manage in the New Zealand grid.

However, wind generation in New Zealand, and by association the electricity market, has a bigger challenge that is not widely appreciated and has major implications for the energy market review.

Ideally wind farms in New Zealand would generate at different times when sited in different geographical locations to provide the grid with a somewhat constant input. In essence when some are not generating, others will be.

Geographically we are a long and narrow country and weather systems generated in the Southern Ocean dominate our weather patterns. As a result, there is surprisingly little diversity in the wind patterns across the full length of the country.

The pressure map for yesterday evening highlights this issue pretty well. All of the country will be windy as the front between the two pressure systems passes over. Later in the week we will all have relatively calm conditions as the high-pressure system passes over the country.

This creates a feast or famine scenario for wind farms, as well as the grid.

How pronounced is this issue?

Transpower has the answer from some work they did in 2021 looking at the output of several New Zealand wind farms over a week in April 2021.

As we can see the wind farms are quite strongly correlated across the country. They are either all generating at near full capacity, or they are all generating very little. I have added the red boxes to highlight the low generation periods.

We can also see that this loss of generation capacity can happen very fast. Take a look at the output between the April 2nd and April 3rd for example (ref. blue box). Here there is a very sharp drop in generation within about an hour totaling something like 360MW dropping out of the grid. When the grid is constrained, this could mean a blackout similar to what happened in August 2021 when 200MW of wind was lost at a critical time.

The market implications of a lack of wind variability across the country.

The absence of wind variability across the length of the country, and the resultant feast or famine supply dynamics, has significant negative market implications for both regular New Zealanders and the wind operators themselves.

1. When it is windy it is generally windy everywhere. When it’s not windy its generally not windy everywhere.

2. Currently there is ~1400MWp of wind generation capacity in New Zealand. For reference New Zealand’s total demand for electricity from all sources is typically between 3000-4000MW. Wind farm operators therefore flood the market when they are all generating, and as a result of this excess supply they command a much lower price in the wholesale market.

3. Inversely when they are not generating, we need 100% back up. This can be for periods as long as several days, and the backup needs to have a rapid response. The wholesale electricity prices during these periods can be very high.

4. The market implications of this are that small wind operators find it very hard to compete. They can’t control when they generate and are always generating into a market that is over supplied. Worse still if they have to compete with hydro, which is our cheapest large-scale generation in a wet year, they will receive very low rates of return.

This is one of the biggest issues that the government’s recently announced electricity market review will have to grapple with. They want to encourage more wind generation, but the weather generated market dynamics do not make this attractive for new or smaller entrants.

What we have already seen in the New Zealand electricity market is that smaller companies’ often develop a wind farm but then sell it off to the bigger operators who use the wind to supplement their hydro and geothermal portfolios. The vast majority of New Zealand’s wind farms are now owned and operated by Mercury and Meridian.

My prediction is that Meridian & Mercury will further consolidate the wind market over time. This is because they can sell their baseload hydro and geothermal into futures markets with low risk and bid wind into the variable wholesale market for more upside by reducing the amount if baseload it is competing with.

Although generally good for Meridian and Mercury it does increase their unit cost of generation.

Some will argue that this will translate into better dry year resilience as they substitute their hydro for wind on windy days. This will likely be the case, however for the average New Zealander this is substituting cheap baseload for more expensive intermittent power. As such I certainly do not expect it to lower our power bills.

Market review expectations

I do not expect the market review to be the silver bullet the Government hopes it will be. I also do not expect it to challenge the base assumptions I refer to as cognitive guard rails, as such I don’t expect a lot to change.

I expect the review to make some suggestions that will more highly regulate the market. As much as I dislike regulation this may help lower power prices in the short term. One such change has already been floated, which is to prevent the big generators from offering preferential lower cost power to their own retail businesses.

However, the big picture is that we need much bigger capex investments than even the biggest players in our small fragmented market can provide. We need big doses of baseload generation with very long lifecycles. Things like geothermal, hydro and nuclear. Flooding the market with wind will make things more complex, more fragile and more expensive.

The market review will not reach this conclusion due to the cognitive guard rails.

It is far more likely to converge on the idea that the government will need to sweeten the pot with some form of subsidies for wind and solar this is likely to be CfD’s (contracts for difference) and curtailment pricing.

This is going to be a problem for the government as they have publicly stated that they won’ provide any subsidies, which I speculated was the ultimate reasons that Bluefloat abandoned their plans for a large offshore wind development off the coast of South Taranaki.

What I predicted in October 2023, the day after the election still stands today…

I foresee that energy will become a key and potentially decisive issue that will plague this government over the coming term as grid fragility, gas supply issues and geopolitical tensions make the standard of living Kiwi’s aspire to even more tenuous.

P.s I know some are thinking batteries will solve this problem. The world’s largest battery is Moss Landing in California it is has a capacity of 3700MWh which is enough to keep NZ running for about 1 hr. It has also been on fire since the 16th of January has quickly become an environmental disaster.