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Are Higher Electricity Prices Here to Stay?
Submitted on September 27, 2019
Spot prices surged late last year when there was a prolonged, unplanned outage at the Pohokura gas field offshore Taranaki. But they haven't come back down to where they were prior to the gas outages. In this post we look at the reasons why and ask the question on everyone's mind – will they remain high?
By Greg Sise, 30 September 2019
Back in 2017 the Haywards price averaged $77/MWh for the entire year, even though the year included two dry periods. For the 2018 year prior to the outages it averaged $76. So far in 2019, with gas flowing from Pohokura as usual, it has averaged around $120/MWh, an increase of 60% relative to 2017.
In our post of 6th March 2017 we explained why gas prices, ignoring the ebbs and flows of hydrological inflows to the hydro storage lakes, are key drivers of electricity spot prices. So it should not be a surprise that gas prices appear to be the main reason why spot prices are consistently higher than they were just a year ago. What is a little surprising, however, is that after prices initially rose due to the outage at Pohokura, they didn't come back down when Pohokura returned to full production.
The gas market is opaque compared to the electricity market, so we have to make largely educated guesses as to why this might be. As long-time forecasters, we've learned that you can never be certain about anything, but despite the lack of transparency in gas, we are confident that the sustained rise in prices is at least partly due to higher gas prices faced by one or more thermal generators. There are a few data points which suggest this is the case.
But as so often happens in these situations, there is not just one factor that goes to explaining high prices, but a combination of factors which are currently all impacting on the cost and capacity of the thermal generation sector.
If we go back to 2016 through 2018, the spot price of gas (including the cost of carbon, which is roughly $1/GJ depending on the actual carbon price at the time) averaged just under $5/GJ, but since October 2018 it has rarely fallen below $6/GJ and has sat at $10/GJ or higher for most of this period. Most gas used for generation is purchased under long-term contracts, but high spot prices are a good indicator that there is a squeeze on gas supply, putting upward pressure on gas prices.
The gas outages of 2018 may have triggered mechanisms in gas contracts that reduced the quantities available in 2019, putting short term pressure on gas supply and on prices as a result.
OMV completed its USD $578 million purchase of Shell's New Zealand assets on 1st January 2019. We can imagine that Shell didn't sell its assets cheap when it exited New Zealand, which could put OMV under considerable pressure to get a return on this investment, given the ban on new permits for offshore oil and gas exploration in New Zealand waters which over the long-term could conceivably limit the total gas available for OMV to sell.
The ban has increased the risk associated with being a gas producer, at the same time as it has obviously reduced the chances of finding more gas. OMV is about to drill new areas offshore Taranaki, and in the established Maui field, and who knows, maybe they find a lot more gas. But maybe they don't, and then their options become quite limited as their remaining exploration permits are offshore the South Is and, if gas is found there, it is not likely to be connected to the North Is gas pipelines that supply thermal power stations.
Methanex is the country's largest gas user, accounting for around 45% of total consumption, and it recently added contracts for half of its total requirements to 2029, in addition to gas already contracted. This is a good strategy when the potential for constraints on gas supply increase, in this case due to the ban on new exploration: contract as much as you can for as long as you can, and as early as you can, to avoid being caught later on with higher prices and limited supply. Unfortunately for other gas users, including gas-fired generators, this potentially puts pressure on the price of the remaining gas not contracted to Methanex.
Most of the gas used for electricity generation is supplied under longer term contracts with firm quantities, but Contact Energy recently announced that 90% of the 10 PJ per annum of gas contracted from OMV's Maui field is "contingent" which means that it is not guaranteed; we assume that it will be subject to a successful drilling program over this summer and into autumn 2020.
MBIE's quarterly update of energy prices for the Jun-19 quarter shows wholesale gas prices on the rise – refer chart below.
Other factors have probably also contributed to the increase in prices. The cost of Indonesian coal suitable for burning at the Huntly power station rose sharply through 2018, though it has partly fallen back this year.
Genesis Energy is also running its 400 MW 'e3p' combined-cycle gas turbine (a.k.a. Huntly unit 5) differently since October 2018. Previously, it tended to run baseload (all the time) but now it runs only when the electricity price or Genesis' hedging position justify incurring its operating expenses. Genesis buys all of the gas from the Kupe field, of which it owns 46%, but production from this field is currently in decline, and will remain in decline until mid-2021 when the field has a compression upgrade to enable more gas to be extracted and injected into the gas transmission pipelines. The decline in production may be a factor in Genesis' decision to change the operating strategy for e3p.
Contact Energy's Taranaki Combined Cycle is only generating to about 300 MW due to an issue with the plant, but is due for maintenance in November which we expect will remedy the problem, potentially adding 60 to 80 MW of thermal capacity.
Contact's Stratford peaking plant had issues last year which were fixed, but the plant has operated with a different offering strategy ever since, which could be due to a physical change in operating strategy (to avoid problems in future) or it could also be due to an increase in the price of gas faced by Contact, or to limitations on gas supply.
Finally, demand for electricity has risen this year due to the restart of the fourth pot-line at the Tiwai aluminium smelter, and also to population growth.
So are higher electricity prices here to stay? Looking ahead, it is evident that for gas prices to come back in the short to medium term, gas producers need to find more gas and need to feel confident that there will be demand for that gas into the foreseeable future. There is obviously a chance that OMV won't find more gas, or that it finds less than hoped for. But Maui has produced more gas in the past, and OMV's commitment to drilling Maui suggests there is a good chance that it will produce more this time. Nothing is ever certain, but we will hopefully have a better idea by the middle of 2020.
On a more general note, like it or not, and whether it was intended or not, the offshore exploration ban has forever changed the dynamics of the gas market, and we are in "uncharted territory". We need to have thermal generation available for the foreseeable future (refer to the final report of the Interim Climate Change Committee) but the key questions are: how quickly does the thermal fleet shrink to the minimum size required to support very high renewable electricity (in excess of 90%)? Will there be gas available at a reasonable price to support the transition to very high renewables without extended price shocks?
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