Submitted on May 26, 2017

After a long period of low spot prices and low volatility in spot prices, hydro storage lakes are emptying out and it’s a timely reminder that the hydro situation can change very quickly.  But it raises the question:  when spot prices start to rise, should I stay on a spot pricing plan, or should I switch to a fixed price plan?

By Greg Sise, 26 May 2017

I was quoted on RNZ’s Morning Report yesterday talking about recent increases in spot prices and falling hydro storage levels in the South Island, and with so many consumers now on spot pricing plans with retailers such as Flick, it is time to look at the risks of a prolonged dry period.

Over the last few years the spot prices have been relatively low and non-volatile.  I love my charts, and this one says a lot. It shows the average spot price (in cents per kWh, exclusive of GST) at a location called “Haywards” for every month since the spot market first started trading over 20 years ago in October 1996.

Haywards price chart

There is in fact a spot price published for about 250 locations on the National Grid, but Haywards is near Wellington, in the middle of the country, and is a good indicator for the rest of the country.

The chart tells us a lot about the way that spot prices behave:  there are long periods when prices are relatively low or non-volatile, interspersed with periods of high prices when the hydro storage lakes get below average.  In the last two or three years, the volatility (the variation from month to month) has fallen away to almost nothing.  That is, until this month.

In the last month, the hydro storage lakes have fallen steadily in the South Island so they are now significantly below average for this time of year, and as a result spot prices have suddenly shot up. For example, last Monday they averaged 10 cents across the entire day.  The exact mechanism behind how hydro storage influences spot prices is quite complicated, so I’ll keep it as simple as possible:  as storage falls, spot prices tend to rise, and they rise faster in the six months from December to May than during the rest of the year.

Let’s focus on dry periods with a series of extreme prices, which we’ll arbitrarily say are prices over 10 cents.  Over the last 20 years there were four events when Haywards spot prices exceeded 10 cents for just one month at a time;  three events when Haywards spot prices exceeded 10 cents for two months in a row;  three events when Haywards spot prices exceeded 10 cents for three months in a row;  and one event when Haywards spot prices exceeded 10 cents for seven months in a row.

Looking at the chart, these events were in 2001, 2003, 2005, 2006, 2010, 2011, two in 2012, 2013, 2014 and the longest of them all, in 2008.

Conclusion:  prolonged dry periods with extremely high prices are relatively common when looking over the long term, but over the last twenty years they have also been relatively short, with only one extending beyond three months.

Let’s suppose you have an “average” household in Wellington and consume around 8,000 kWh per annum and, to keep things simple, let’s suppose you consume 60% of that during the winter heating season from May to September – a total of 4,800 kWh.  If the spot price averaged 10 cents during that entire period, the additional you would pay relative to the benign conditions experienced in the last two years, at Haywards, when spot prices at Haywards average 5.4 cents, would be $220 plus GST ($250 including GST).

If a severe dry period were to occur and the spot price averaged 15 cents over those five months, then you would spend an extra $460 plus GST ($530 including GST).

The extra amount you would actually spend in the examples above depends on a number of factors including how much you consume at night versus during the day, or week versus weekend, how much is spent on hot water and space heating, and so on.  But these calculations give you a rough indication of the risk you take by staying on your spot pricing plan.

Your alternatives include staying on spot pricing but making efforts to reduce your electricity consumption or move consumption into periods of the day or week when prices are lower, e.g. do the washing in the weekend, or put the dishwasher on just before you go to bed.

Or you could switch to a retailer offering a completely fixed-price on electricity.  If you think you might do that, consider doing it sooner rather than later, because if you hesitate too long you might find that you switch just before it rains and the spot prices fall again, thus paying more during the dry period but then not getting the benefit of lower spot prices after the dry period.

Finally, I have to add a disclaimer:  all of the above is based on the spot market over the last 20 years, with a ‘safety margin’ added in the example of with prices averaging 15 cents for five months.  However, I can’t guarantee that the safety margin I used is large enough to cover all possible future scenarios.