The language may be measured, but the Electricity Authority’s report into Rio Tinto’s cut-price electricity agreement is damning, writes Bernard Hickey.
On January 14 this year a good chunk of the South Island, and Invercargill in particular, celebrated what appeared to be a big and surprise win. Rio Tinto announced it had decided to keep running the Tiwai Point aluminium smelter for another four years after doing a new cut-price deal with Meridian Energy to buy Lake Manapouri’s electricity 24/7 for around $35 per megawatt hour (MWh). That’s less than a sixth of the wholesale prices being paid by other power users at the time.
The global mining and metals giant had thrown the cat amongst the electricity market pigeons just six months earlier by threatening to shut the plant as soon as August 2021, saying low aluminium prices and high power transmission costs made it uneconomic. That would have carved over $1b worth of salaries and export receipts out of the economy at a time much of the South Island was dealing with the collapse of its tourism industry. Nearly 1,000 highly-paid and specialised workers would have been out on the scrapheap. Many would be unable to work again if they had stayed in South Island.
Back in mid-2020, Rio Tinto had appeared serious about leaving by August this year. This government had refused to repeat the Key government’s decision in 2013 to stump up $30m to keep the smelter going. It appeared agnostic about keeping the smelter at all, while the Greens were actively goading on Rio Tinto to pull the plug. Plenty of locals thought the powers-that-be had finally called the smelter’s bluff.
It was largely left in the hands of energy companies Meridian and Contact to come up with a big discount to encourage Rio Tinto to stay. So the decision on January 14 was quite the mid-summer tonic for the economy and the government. Luckily, it seemed, the shareholders and boards of these two listed power companies had taken one for the team of five million by offering a really sharp deal. The sigh of relief from Bluff on up the South Island was almost audible in Wellington.
But was that actually true? Were Meridian and Contact actually the losers? Plenty of their retail market competitors were sceptical, especially when wholesale electricity prices started escalating rapidly as soon as the decision was announced on January 14.
Wholesale prices doubled almost overnight to around $200/MWh. Through this year the pain escalated for many buyers on the wholesale markets, including those large users such as the Norske Skog paper plant at Kawerau and the Glenbrook steel mill. It was one of the factors in the Kawerau plant’s closure at the end of June with the loss of 160 jobs, a month after prices rose over $300/MWh. This surge in wholesale prices through the first half of 2020 also wreaked havoc for those electricity retailers such as Flick Electric and Electric Kiwi that rely on buying from the wholesale market. They scaled back their competition for new customers. Other smaller players were driven over the brink to closure.
So what actually had happened? Was there something wrong with the wholesale power market? The likes of Flick Electric, Electric Kiwi and the Major Electricity Users Group certainly thought so, declaring their complete loss of confidence and variously calling for structural separation of the generator/retailers, or the creation of a KiwiPower to own Manapōuri.
In March, the market’s regulator, the Electricity Authority, launched a “Monitoring review of structure, conduct and performance in the wholesale electricity market”, from which it also produced a paper entitled “Inefficient price discrimination in the wholesale electricity market – Issues and options”.
The results of those two papers were laid out this week for the industry, and the government, to chew over. The language of the EA’s findings and conclusions was typically cautious and limited, but the implications were explosive.
In short: the EA found the industry appeared to have deliberately given Tiwai Point a separate off-market and very sharp deal to avoid having to dump the power onto the broad wholesale market, which would have lowered prices and profits across the board.
Meridian and Contact had effectively agreed to sell power to NZ Aluminium Smelters (NZAS) for $500m less than it cost to produce, but taking that hit was worth it because it meant they could charge as much as $850m extra per year for the power they sold to other users in the wholesale market. A win-win-win deal for Rio Tinto, Meridian and Contact shareholders, but not for the rest of their customers.
“In the case of the Tiwai contracts, it appears that generators have effectively subsidised the price of electricity to the NZAS and, as a consequence, prices have remained higher for other consumers,” the EA wrote.
That move probably inflated consumers’ power bills by up to $200 per year and would cost the buyers of electricity, including industrial and commercial users, anywhere between an extra $1.6b and $2.6b over three years, it estimated. The annual premium was up to as high as $850m, which goes straight to the gentailers’ bottom line and into shareholders’ coffers.
“We estimate that the result of the smelter staying open means spot market costs to purchasers are higher by between an estimated $1.6 billion and $2.6 billion over three years, an increase that will translate into spot prices over the next three years,” the EA wrote.
“Any effect on prices will ultimately be borne by consumers, with an impact first on commercial and industrial consumers, because their contracts are more closely linked to spot prices than residential consumers’ contracts.”
The EA’s boffins estimated the efficiency cost to the New Zealand economy of the low price paid by the smelter at between $57m and $117m a year.
Its conclusion was cold and galling for those who had alleged for years that the big gentailers had played the wholesale market to inflate their profits:
“Generators may be willing to subsidise NZAS because its demand increases national prices and spot market revenues by as much as $850m per year, more than offsetting the cost of the subsidy.”
To rub it in, the EA followed up with:
“All large generators, not just those that are a party to the Tiwai contracts, benefit from the higher spot prices for their generation. Therefore, it is rational for generators to agree to a discounted price for the electricity supplied to NZAS, in exchange for NZAS’ longer term commitment to stay when that commitment results in additional revenue from other consumers that exceeds any loss from the discount.”
But the criticism was more than about the fairness of the market. The EA suggested the gentailers were also holding back from investing in new renewable electricity generation because they knew adding to supply would suppress prices.
“Investment in efficient and low carbon technology needs to displace legacy technology, but the rate of new investment in generation has been slow in recent years,” the EA pointed out, estimating investment of $27b to $37b was needed by 2050 to match growth in demand and replace coal and gas plants as the nation moved to carbon zero.
The EA wanted to give the industry the benefit of the doubt about why so few new renewable plants had been built or commissioned, despite the high prices sending all the incentives to build more.
“A variety of reasons exist for this, including: delays in the consenting process; a reported need to update consents for new technology; the need for transmission connections; and some reported delays while firms await certainty around government policy,” it wrote.
However, the EA indicated its analysts had found that “generator–retailers may still be making investment decisions with regard to maximising returns on their existing assets”.
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The wholesale market’s critics say they were hardly surprised to see the referee blow the whistle on what they had been seeing for years, but it was some sort of progress.
“It’s good to see the EA has acknowledged there is evidence of market power being abused,” said Electric Kiwi CEO Luke Blincoe.
However, he was disappointed the EA had not recommended specific ways to reform the market, other than to vaguely suggest side-deals such as the Meridian/Contact deal with NZAS be pre-approved by the EA or that the “use it or lose clause” currently applied to the smelter be banned.
Meridian ran straight to the referee with its arms outstretched and an incredulous look on its corporate face. CEO Neal Barclay accused the EA of inaccurate speculation and of effectively being naive.
“The authority’s incorrect view about the price under the NZAS contract has potential implications for all large businesses in Aotearoa. If companies that need a lot of electricity cannot sign commercially competitive deals, they simply cannot survive,” Barclay said.
“If we follow the EA thinking in this paper, it will mean this electricity market would operate differently to every other market. The price per apple for a million apples is a lot less than the price per apple for a bag of apples. That’s how markets work,” he said.
So what does the government think of this apparent confirmation of an uncompetitive market and the industry’s prioritisation of easy and big profits over more renewable power generation?
“I, like many New Zealanders, will be disappointed that the initial findings appear to show households and businesses are subsidising a multi-national to the tune of $200 per household,” said energy minister Megan Woods.
“I welcome the consultation the EA has started, but I am not ruling out looking at what interventions might be required to ensure this can’t happen again, including the possibility of structural change in the sector,” she said, adding she wanted consumers treated fairly in a market without distortions that encouraged more renewable investment.
“In the meantime I have asked officials to investigate options proposed through the Electricity Price Review, that were not recommended, to see if they should be revisited.”
In rugby terms, that is a safe exit from the 22 to buy time for some tired forwards to take some deep breaths.
The government’s problem and (just quietly) its good fortune is that its 51% shareholdings in Meridian, Genesis and Mercury mean it is the single biggest beneficiary of the super profits generated in a market that favours the gentailers.
It may say it wants to reach carbon zero by 2050 and 100% renewable electricity by 2030, but Treasury will also be pointing to the billions in dividends the government will receive over the next eight years from the status quo.
Electric Kiwi’s Luke Blincoe is not hopeful the government will force the market to favour consumers any time soon.
“They’re completely conflicted because of the dividends they’re trousering,” he said.
Meanwhile, the 13% of Aotearoa’s power used by the Tiwai smelter is effectively a road block on the path to carbon zero. The Climate Commission’s assumptions about the relative ease of reaching carbon zero were predicated on a fast closure of the smelter driving prices down 30% to encourage car drivers and boiler operators to move to electricity, as well as taking a whole swathe of coal and gas out of production.
Instead, this year, Huntly has been running its coal boilers hard through the winter to generate electricity for Auckland. The renewable share of electricity generation dropped from 85% to a six-year low of 81% over the last four years.
The amount of coal burned to generate electricity in the last year to June 30 was 1.48m tonnes, more than double the 661,000 tonnes burned the previous year.
A market designed to produce affordable, reliable and increasingly renewable energy instead delivered a doubling of wholesale prices, super-profits of almost $1b a year and the most coal burned in almost 15 years.
The closure of Tiwai Point in August this year, as Rio Tinto threatened, would have changed all of that for the better. The smelter is currently scheduled for closure at the end of 2024, but that is not certain either. Aluminium prices have more than doubled since mid-2020 when Rio Tinto was sure it couldn’t sustain the smelter without a big power price cut.
Bluff aluminium is in especially hot demand because it can claim to be among the greenest in the world, as it comes from pure hydro generation.
It’s not just a road block, but also quite the toll booth for extracting a subsidy from consumers that also generates a super profit for shareholders.
The government will this weekend reveal its beefed-up Nationally Determined Contribution to reduce emissions by 2030. Climate change minister James Shaw needs to take a big number with him to the COP26 conference in Glasgow. That is much harder while Rio Tinto churns through more than a quarter of our renewable power each year and pumps out around the equivalent of 700,000 tonnes of carbon dioxide from its potlines when the bauxite ore is converted to aluminium.
To add to the toll, the smelter also receives $48m of free carbon credits to use in New Zealand’s emissions trading scheme.