Goodbye pork pie? The demise of major industries and wider implications for New Zealand’s transport sector

Several major industries in New Zealand may be in their death throes.

First came the news last week that Tiwai Point was looking to renegotiate their electricity price contract with Meridian, apparently because of plunging global aluminium prices. Then we heard that Norske Skog is looking to halve the production of pulp and paper at their Kawerau Mill, again because of plunging prices for newsprint.

Now, these two industrial consumers on their own account for approximately 18% of New Zealand’s annual electricity consumption. So it’s reasonable to wonder what would happen to the price of electricity if they were to close down? Obviously it would drop, but by how much?

To get a handle on how changes in the demand for electricity might affect its price the first port-of-call are so-called “offer curves”, such as the one shown below. This offer curve has price on the vertical axis and supply on the horizontal axis. The blue line is the set of offers submitted by the electricity generators that you know and love (Meridian etc) to supply electricity to the market operator.

The offers are basically the price the generators need to be paid to make generating electricity worth their while (i.e. the financial equivalent of what you have to pay to get me out of bed in the morning). Of course the individual generators have a number of plants in their portfolios that all have different cost structures, hence each generator will make a multitude of offers. The offers are then sorted from highest to lowest, which creates the upwards sloping step-wise blue line shown below, which is labelled “aggregate offer curve.”

The market operator then accepts as many individual offers as is needed to meet the total demand for electricity in that period (which is predicted by Transpower based on historical demands and trends, plus some allowances for weather conditions). The total demand for this particular period is indicated by the vertical blue line.

The point where the demand (vertical blue line) hits the aggregate offer curve (step-wise blue line) determines the clearing price for this period, which in this case is found to be $120/MWh (or 12c/kwh), as illustrated by the horizontal grey line. If you’re an offer sitting to the left of the demand line then you will be accepted; if you are an offer sitting to the right then you get nothing.

Now, it’s worth dwelling on this offer curve for a bit – and it’s not simply because  I like graphs. The main thing to notice is the J-shape of the offer curve, i.e. it starts off at zero and stays there until the quantity demanded reaches just over 3000MW, at which point the offer curve starts to step upwards. As the quantity demanded increases further then the offer curve increases at an increasing rate. Basically, the offer curve (and hence the price) will accelerate as demand grows, and vice versa if it falls.

At this point you might be sitting their and thinking “but why would anyone offer to generate electricity for $0?” The answer is that no-one expects to receive $0, but the reason they are made is because they are associated with “must run” generation – e.g. most geothermal, wind, and run-of-river hydro (e.g. Waikato river system). Because these plants cannot just be “switched off” the generators will offer them in at close to zero in order to make sure they make the cut – but they do so in full awareness that the actual demand is likely to push the clearing price further to the right and thus beyond the territory where zero prices would hold. To the right of this must-run generation in the offer curve sits more “flexible” generation options, such as lake hydro and thermal (gas and coal – although the latter is slow to start up). It is this generation that will in most cases that will set the clearing price.

But we digress slightly. Our original question was: How might the price of electricity change in response to changes in demand? Let’s consider two scenarios to provide us with some insight into this question:

• Scenario A – demand is 15% higher at 5,060MW. In this situation scenario the clearing price would shift to about $250/MWh – or approximately twice the actual price.
• Scenario B – demand is 15% lower at 3,740MW. In this scenario the clearing price would shift to about $60/MWh – or approximately half the actual price.

These scenarios illustrate that a demand shock in the order of 15% can cause much larger changes in the wholesale electricity price, i.e. the shape of the offer curve (or structure of the market for electricity generation) means that relatively small changes in demand can have relatively large impacts on price.

It’s important here to note that the offer curve is based on the short run marginal cost, which will be more volatile than the long run effects. This is because permanently suppressed  prices would motivate the generators to mothball costly power stations, which would in turn push the price of electricity back up to the point where it was financially sustainable (in the sense that it was enough to cover the long run costs of capital). So the long run effects of a large change in demand will be smaller than the short run effects.

But nonetheless significant. And the impact of Tiwai and Kawerau would be felt most immediately through a fairly large fall in NZ’s electricity price. Residential electricity bills would drop, so consumer expenditure would increase. And any surviving electricity-intensive industries would suddenly become that much more viable – because they would all be paying much less for their electricity. BlueScope Steel at Glenbrook, for example, springs to mind as a company that could do quite well out of Tiwai and Kawerau shutting down.

A wider implication of a large drop in the price of electricity, however, (and the one that is probably more interesting to the readers of this blog) is that electric  transport would become significantly less expensive. That means that Wellington’s trains and trolley buses, and Auckland’s soon-to-arrive EMUs for that matter, will be relatively less costly to operate. Of course electricity is only one input into operating costs, so we would expect the reduction in operating costs to be less than the reduction in the price of electricity.

But the big impact, I think, is likely to be on the viability of electric buses: A significant drop in the price of electricity in New Zealand would probably mean that these would become viable on a relatively large scale. Fully electric buses are already operating on in cities overseas, such as the Artic Whisper that s operating in Umeå, Sweden (hej på dej!) shown below. But these places have much higher electricity prices, hence electric buses will normally require subsidies.

The Artic Whisper is particularly interesting because it runs standard-size full electric buses, which recharge quickly at the end of each trip via the overhead system shown below. It also has a back-up diesel engine that can be relied on if the electric battery runs down (quite useful in the Swedish winter), so it is quite a resilient technology.

Other cities such as Turin also has some cute little battery electric buses, although these have smaller capacity so their application is more limited. But my point is that there’s a range of reasonably established electric bus technologies out there and that they might come here if the price of electricity dropped to a significant degree.

All this leads me to think that there may actually be some positives in a future where Tiwai Point and Kawerau shut down. The most obvious is that electricity would be likely to be significantly less expensive. In the medium to long run that has to result in additional jobs being created somewhere else, such as Glenbrook (altough the electricity generators would probably have to shed staff).

But the potentially most exciting impact of a large and sustained drop in electricity prices would be on the public transport sector, where fully electric buses might become viable. All our cities could then breathe a sigh of relief from cleaner, quieter streets – and in the long run electric technology could even change people’s perceptions towards buses (which I still think for many NZers are coloured by too many bumpy school bus trips in cluttery old diesel beasts driven by dragons).

That’s not to suggest that I hope these two major industries do shut down, because this would no doubt devastate the economies of their local communities. But I do think it’s important to think through what the potential implications might be – especially before people start suggesting that the general taxpayer “support” these industries in some way (even through lower electricity prices).

My economic instincts tell me that rather than knee-jerk support for what are foreign-owned and potentially dying industries, New Zealand would be better off responding to such a shut-down by directly supporting the affected communities/households, i.e. help them adapt to change – rather than fight it. And because the electricity resources currently being consumed by these industries will result in lower prices overall, then everyone else will have a bit more money in our pocket to help out those people who are adversely affected.

Just some of my thoughts; keen to hear what others think.

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