• Paul Farrelly

Impacts of the Tiwai Point Aluminium Smelter exit – what does it mean for power users?



Background

Unless you’ve been hiding under a rock you will be aware that Rio Tinto, the owners of the Tiwai Point aluminum smelter (Tiwai), have announced they will be ceasing operations in August 2021.

On the surface of it, it would seem to most that NZ electricity prices are set to drop substantially. Tiwai is responsible for consuming 13% of NZ’s electricity and according to the laws of supply and demand, a significant reduction in demand should lead to a big price drop.

However, electricity pricing in NZ is a very complex beast, with a wide range of variables at play and simple economic theory doesn’t always tell the right story. This makes it very difficult to assess just how much prices might drop by, and when this will happen.

What we can say is that there is unlikely to be a significant impact on wholesale prices in the next 12 months as Tiwai will continue to operate until August 2021. From that point on a drop in the price of electricity can be expected, and this is already being seen in the price of electricity futures (which is the basis for commercial electricity contract pricing).

However, counting against big price drops is the expectation that the over-supply will be reduced by the closure of some thermal plants in the North Island (Huntly and Taranaki). Additionally, new generation build projects that were in the pipeline will also be delayed. For example, Contact have already said they will now defer the build of a new geothermal plant near Taupo that is ‘shovel ready’.

These actions will reduce supply to better meet the reduced level of demand and will limit the extent of price drops.

Q. Is this a done deal?

A. We think so. The government have ruled out stepping in to save the smelter, and the smelter’s main suppliers – Meridian and Contact – have made it clear they have already made their best offer and won’t negotiate further.

Q. Was this a surprise?

A. Yes. Until last week the strong market view was that the smelter would continue to operate for at least the next few years.

Q. Will I be getting a price reduction on my next contact? How much will it be?

A. You will most likely see a reduction, and you almost certainly will if you are in the South Island. At this stage we can’t say by how much. It will depend primarily on where you are located, what sort of contract you have, when you signed your last contract, and when your current contract ends.

To give you some sort of a gauge, if you are on a time of use (TOU) contract then your reduction could be in the range of 2 – 3 c/kWh (or 20 - 30% of energy only costs, assuming your average energy price now is around 10 c/kWh). The reduction will be greater if you’re in the Lower South Island, and less in the North Island.

If you have a non-TOU (NTOU) contract you are unlikely to see such significant movement, as prices for NTOU contracts typically do not track the wholesale market in the way that TOU prices do. For instance, NTOU prices didn’t go up much when wholesale prices jumped in late 2018, and they didn’t drop much at the start of the COVID-19 pandemic either.

Q. Why does the extent of the price drop vary by region?


A. The energy used to power the smelter comes primarily from Manapouri Station (in Fiordland) and major transmission upgrades will be required in order to get the energy out of Southland and to the rest of the country. These upgrades will take time (several years) and will be expensive.


While these upgrades take place, there will be a large energy surplus initially in the Lower South Island, then the whole of the South Island and eventually the North Island. Prices will naturally be lowest in regions where there is an energy surplus. And as we’ve already suggested, it is likely that thermal plant in the North Island will be shut-down, which will suppress price reductions, especially in the North Island.


Q. How long will prices be lower?


Some commentators are suggesting that prices in the lower South Island may not recover to current levels until 2030, but this may change if major electricity demand growth occurs – such as substantial electrification of process heat (e.g. Fonterra), or the building of a huge data centre, Tesla Gigafactory, hydrogen generation plant or similar.


But even if all of that were to happen, it may not fully replace the level of energy consumed by the smelter. So that means a large surplus of the energy from Manapouri will need to be distributed to the rest of the country.


This requires a series of transmission upgrades, which will be expensive (> $500m), take 5-7 years to complete and ultimately power users will end up paying for these upgrades through their network charges.


Q. So will my network charges increase?


A. Yes unfortunately. Your electricity cost is made up of energy charges and network (lines/transmission) charges. The Tiwai exit will actually increase your network charges because Tiwai currently pays for around 13% of the cost of the National grid.

When the smelter goes, the costs of running the national grid will need to be re-apportioned across everyone else. So, your lines charges will increase as a result. And, additionally, power users will also need to pay for the transmission upgrades required to get the Manapouri energy to the rest of the country.

At this stage it is not clear how the charges will be apportioned, but we expect that large users will continue to be charged on the basis of their peak demand, so you should continue to manage your peaks.

Q. I still have a couple of years left on my contract – can I get a price reduction now?

A. Unfortunately the answer here is most likely no. From what we are seeing, the retailers are taking the approach that existing contracts were negotiated in good faith and at the time of contracting the prices agreed were reasonable. However, we do expect to see some retailers being prepared to renegotiate the last 6-12 months of an existing contract in exchange for a customer agreeing to an extended next contract term.

Q. What should I do to get the best price on my next contract?


A1. Test the market with a competitive tender. Given that we may witness a ‘price war’ as retailers move to fill the gap in revenue left by the loss of Tiwai, we think that large users should be undertaking full market tenders.


There is likely to be a wide spread in the prices on offer by suppliers, and the cost of tendering is relatively low so we think there will be good value going to the market. We can assist with this.


A2. Be prepared to sign up to an extended contract term (>3 years). As earnings from generation become less certain for the big players, it will be in their interests to have long-term supply contracts with customers and so we expect they will be prepared to offer better deals in return for longer contracts.


Q. Should I continue to focus on energy efficiency?

A. Yes! Being energy efficient is still the best way to control your energy costs. You have little control over market prices, but you can control how much power you use and when you use it.

Given we expect that network charges will increase, and these are typically based on peak demand – we think managing your peak load will become more important in the future.

Q. Will the Tiwai closure result in a lower emissions factor for NZ electricity?

A. Yes, we expect so. It seems likely that some of the North Island thermal plants (gas and coal fired) will shut down, which will mean that a greater percentage of NZ’s electricity generation will come from renewables. Currently 85% of NZ’s supply is renewable – we expect this will increase to around 90%, so as a result the emissions factor for NZ electricity can be expected to reduce, perhaps by as much as 50%.

This will be of benefit to your carbon footprint and will reduce the cost of any off-sets you are required to purchase if you are CarbonZero.

This will also make the choice of electricity over other fuel sources – like gas or coal – relatively more attractive from a sustainability and economic stand-point. For example, the energy costs of running heat pumps and natural gas for low temperature heating are currently similar, however the energy related emissions for a heat pump are around 1/6th of that for a gas boiler. The reduction in electricity costs and increase in renewable generation due to the Tiwai point closure is likely to make heat pumps significantly more cost effective to run and closer to 1/10th of the emissions of a gas boiler.

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