Submitted on March 28, 2021

By Greg Sise, 29thMarch 2021

 

Just about every day we hear more about low lake levels and tightening gas supplies.  Spot prices seem to keep climbing, as do electricity futures prices.

 

But are low lake levels and tight gas supplies the only factors affecting prices?

 

The short is Yes, but the long answer is no, not in the longer term.

 

In the short term, the amount of wind generation on any given day, and in any given trading period (half hour), has a big impact on spot prices:  low wind, higher prices, and vice versa.  On average, winter wind speeds tend to be lower on average than summer wind speeds, at most of our big windfarms, so we are now in a calmer period of the year. But, hey, this is New Zealand, one of the windiest countries in the world!  (Which as a keen water skier, looking for calm water to ski on, frustrates me immensely!)

 

In the medium term, however, the hydro lakes have seen lower than average inflows since late last year (see more detail in Hydro Watch). The trend toward drier summers appears to be (I say ‘appears to be’ because there is still uncertainty about this) the result of climate change, which tends to make summer and early autumn drier in the relevant catchments but also wetter in winter.

 

But key lakes, Puakaki and Taupo in particular, are now much lower than expected for this time of year, and their operators are working to conserve water in these lakes, which they do by offering less power into the spot market at lower prices, and more power at higher prices.

 

At times like this, we start to hear people talking about it being “dry all winter” and so on, but I’ve heard it all before, and the reality is that no one can predict localised precipitation with any accuracy more than a week or two ahead, at most.  There only has to be a ‘blocking’ system sit alongside New Zealand for a few days (as occurred recently in New South Wales), and we could have loads of spill and flooding in the southern hydro lakes:  it can all change within a week.

 

If we look at the historical record back to around 1930, there are only one or two years in which hydro inflows remained low all through winter and into spring.  We can be sure it will rain, and probably sooner rather than later, but there is a small but definite probability that we’re in a dry period that could span several months:  we can be sure that hydro generators are very aware of this, and will be managing water conservatively as a result.

 

The following charts show the marginal generator (the generator setting the spot price) in each trading period over the course of a week, in both islands, and what really stands out (apart from the high prices) is that there is more than just one or two generators on the margin.  Any generator that could be marginal, which includes all of the larger generators in the market, has to price their offers relative to the market, even if their costs are lower than other generators, to avoid being dispatched for more than they are willing to supply.  In other words, it’s a balancing act.

 

 

 

Which brings us to the longer term, and first we look at gas supplies.  At the core of the current gas supply problem is the continuing decline in production at the Pohokura gas field, shown below in blue (courtesy of the Gas Industry Company, and showing daily production).  This started in May last year, was interrupted by an upgrade of the field’s gas compressors in September, but continues to this day.  Pohokura is New Zealand’s largest gas field and its production is expected to be down by a whopping 44% this year; that is a lot of gas to take out of the market (just over 30 PJ or about 16% of total annual gas production).

 

 

Pohokura’s operator, OMV, says the problem is to do with scaling in the offshore wells, which simply means that a thick layer of scale is progressively growing on the inside of the well and blocking the gas flow.  To remove the scale requires a drilling rig to be brought down from Singapore (these rigs are expensive to buy and operate, so there is no suitable rig based in New Zealand), jacked up beside the Pohokura offshore platform, and the scale is then either milled (drilled) out of the well or removed chemically.  In the worst case, I guess a well might need to be abandoned and another well drilled:  this takes months of planning, and weeks to actually drill.

 

When oil prices tank, like they did last year, rigs are plentiful, but oil prices have come back up, and OMV says that it will be 2022 before a rig arrives, after which it will take weeks or months to descale the wells, if they can be descaled.

 

Methanol producer, Methanex, has mothballed its Waitara Valley production train, due to the reduction at Pohokura, but is now also reporting that it may not have enough gas next year to run its two other production trains at Motonui at full throttle.  This suggests that concerns about gas supplies are moving beyond “when will Pohokura return to full production?” to “will it ever return to full production?”  If it doesn’t, then there are long term implications for gas and electricity supply.

 

Comprehensive information about key gas contracts and supplies for thermal generators has always been hard to obtain.  For example, during the major outage at the Pohokura gas field that started mid-September 2018, spot prices started to rise, and we could see that something was “going on”, but it was only at the very end of September that announcements were made to the market.

 

But disclosure is improving, and this week we learned that Nova Energy (owned by gas producer Todd Group) agreed to divert 3.6 PJ of gas that it would have used for its own generation, to Contact Energy for use in its Taranaki Combined Cycle gas plant, which is a significantly more efficient generator than those operated by Nova.  The gas is priced at “market prices”, which we think could be up to two and a half times more than what Contact expected to pay for its gas this year.

 

Genesis Energy imported much more coal last year than it has for the last few years, and has made all three coal-fired units at the Huntly power station available to run, whereas it had planned only to run two units this year.

 

So, we can see that efforts are being made to ensure there is enough generation to get the country through a dry winter.  But with restricted gas supplies, and the opportunity cost of gas at all-time highs, the cost of generation has risen sharply, along with modestly elevated risks of the lakes getting low enough to cause real concern about actual shortages in winter (Transpower reported this week that “an extended period of low inflows or significant additional non-hydro supply disruptions could lead to a rapid change in risk.”)

 

There are other, larger forces in play, however.  Demand growth since 2009 is much lower than the long-term average, and when this is combined with the possibility of Tiwai leaving the market at shortish notice, it’s not hard to see why there hasn’t been much new generation built lately. With some more certainty over Tiwai achieved earlier this year (it will stay until the end of 2024, perhaps longer), and with policy targets around decarbonisation looking to get much stronger in the next year or two, there is a lot of new plant going to be built over the next decade.  

 

But it will take a couple of years for the first of this to be built and commissioned, and in the meantime, we await more news about Pohokura and its prospects.

 

At times like this, everyone is concerned about high prices continuing much longer, and the possibility of shortage looms just a little larger.  But chances are, it will rain before winter, if not sooner, and the situation will ease. 

 

Or at least we hope it will.

 

But as we quoted in a recent post, hope is not a strategy, and in the meantime the hydro operators need to be conservative with water, which means thermal plant needs to run more, and thermal has gotten much more expensive, so prices will stay high, especially while the wind is not blowing.

 

Speaking of which, I hope it is calm next week for our last Wednesday night water ski of the season…

 

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