New Zealand developments may pause

Supply and demand needs time to find a new level

In the short to medium term we expect to see some instability in the New Zealand market as dynamics adjust to the departure of NZAS and the running down of thermal capacity. We’ll continue to grow our connections with our customers.

In New Zealand, opportunities to grow our renewable generation portfolio rest on demand growth and the retirement of thermal power plants. With NZAS announcing the closure of the Tīwai Point aluminium smelter, there is in the short term an oversupply of renewable energy in the South Island that will struggle to move north. Demand for new renewable-energy power stations is likely to increase regardless of this situation, as we expect thermal plant closures to continue in the medium term.

Heading into temporary oversupply

The biggest variable the electricity sector in New Zealand faced for many years was when New Zealand’s Aluminium Smelter at Tīwai Point would close. Just after the financial year ended, we were notified by Rio Tinto, the majority owner of the smelter, that it would terminate its contract with us with effect from 31 August 2021.

In October 2019 we were advised by NZAS’s major shareholder, Rio Tinto, that it intended to conduct a strategic review of the smelter. The review would look at all options for the future of the smelter, including the option of closure.

Our electricity contract with NZAS included options for NZAS to terminate the agreement in full or to reduce consumption from 572MW to 400MW with 12 months’ notice. NZAS advised us that volatile international prices for aluminium, relatively high energy and transmission costs and an upcoming refurbishment bill to keep one of the potlines operational had brought the future viability of NZAS into question.

In response we engaged in good faith, tabling a number of proposed changes to and concessions in our existing contract. We believed the changes were generous and pragmatic and would support the smelter’s ongoing viability while still balancing the interests and expectations of our own shareholders.

Rio Tinto indicated that it would provide the market with an update on the strategic review by the end of the first quarter in 2020. That decision was delayed until July. During April, NZAS exercised its right to suspend the contract that supported its 50MW Potline 4 for up to six months, citing the COVID-19 pandemic as the reason.

Recently, the announcement of new Transmission Pricing Methodology guidelines would have meant further transmission cost savings of $10 million per annum for the smelter from 1 April 2023. NZAS would have also been able to apply for a prudent discount, potentially further reducing its annual transmission bill from Transpower. We hoped that this announcement would strengthen the case for the smelter to stay in operation, but the smelter owners made a different decision. Meridian had always prepared for an exit of the smelter as a real outcome.

NZAS consumes around 40% of Meridian’s generation output in any year, depending on generation output and demand. Their exit from the market represents a significant reduction in demand and will likely result, in the near term, in a reduction in Meridian’s revenue, largely caused by a reduction in electricity prices (both wholesale and retail). The size of any such reduction in Meridian’s revenue and associated losses, and therefore the severity of the impact on Meridian, will depend on a number of variables, including transmission constraints, the rate of residual New Zealand electricity demand growth and the response by generators and electricity market participants. For example, other electricity generators with thermal generation plant could choose to mothball or retire their plant, which could have the effect of reducing the supply of electricity and moderate any reduction in wholesale electricity prices.

Once NZAS leaves, more renewable energy will be available from our country’s South Island hydro stations as long as the power can be sent north to where it’s needed. This will help to displace fossil fuel power stations and will make a significant difference to the percentage of renewable electricity on the grid.

We’ve been working closely with Transpower, along with Contact Energy, on the Clutha Upper Waitaki Lines Project. In FY20 we contributed $5 million to fund early work on the transmission line to help expedite increasing transmission capacity. We welcome and commend Transpower’s response and collaboration. Transpower has said that the completion date for this is May 2022.

The full implications for the New Zealand electricity sector and for Meridian’s business are still being worked through. While the loss of such a large consumer of electricity will be disruptive in the near term, we’re confident that the opportunities it affords to both our country and Meridian will ultimately offset any short-term negative impacts.

Demand – one step back but likely two forward

In the short term, the sector is likely to see a significant reduction in demand with the closure of the aluminium smelter at Tīwai Point. However, in the medium to long term, our overall view for the future is for significant positive growth.

This is not easy to forecast. A number of factors can impact demand, including activity levels in the industrial sector, competitor behaviour, regulatory changes, population growth, economic conditions, technological advances in the more efficient use and generation of electricity (including by customers, potentially as a consequence of regulatory subsidisation of competing technologies), weather and catastrophic events. All of these could in turn affect electricity prices.

As New Zealand commits to its climate-change goals and Government, businesses and individuals start to lean into our collective challenge, we expect to see increasingly faster electrification of both the transport and stationary energy sectors that rely on burning fossils fuels. These changes will go a long way to reducing New Zealand’s energy-related greenhouse gas emissions and will grow the demand for new renewable electricity in New Zealand.

The physical impacts of climate change may also increase demand, due to higher demand for air conditioning in summer, and higher irrigation requirements in the agricultural sector, partially offset by lower demand for heating in winter.

Combined, these increases in demand offer Meridian the opportunity to grow our electricity generation and retail businesses.

It’s not all good news though. Climate change could also lead to a negative impact on our demand, if climate action policies curtail a high electricity consuming industry, for example the dairy industry.

The business case for development

The ongoing impacts of the COVID-19 pandemic have created significant uncertainty for demand growth expectations in the next few years, with general recessionary effects and trade-exposed industries likely to limit growth. However, as local and global economies begin to recover, we expect underlying demand growth to eventually return but at fairly modest levels (around 5% per annum). Beyond this, as decarbonisation efforts begin to accelerate, we expect demand growth to increase further (to as much as 1% per annum). In the next decade this equates to growth of between 2,000 GWh and 4,000 GWh.

But modest demand growth doesn’t necessarily mean that new power stations won’t be needed. Despite the oversupply of renewable energy that the exit of the Tīwai smelter will create, we’re expecting in the medium term that this energy will displace thermal power stations, and there’ll be a need to replace energy from any power plant that’s retired in the next 5-10 years.

Accordingly, in the past few years we’ve built up our internal capability to develop and execute new projects, from wind projects such as the ready-to-go Harapaki wind farm to large-scale solar and grid-scale battery systems. Wind will be an important part of that future, and we’re buoyed by the fact that the costs to deliver new wind capacity have reduced significantly.

As part of our commitment to SDG13 Climate Action and SDG7 Affordable and Clean Energy, we continue to investigate how we can support a faster conversion of the Australian electricity system to renewable energy. Our strategy is to continue to develop our generation portfolio through acquisition and development and expand the pipeline of assets to eventually include wind, solar and battery developments. By continuing to invest in renewable energy we’re looking to build a business in the Australian market that’s attractive to consumers, is good for the country and the economy, and supports the ongoing growth and profitability of the Powershop brand.