1. 8 Halswell St PO Box 12332 Thorndon WELLINGTON New Zealand +64 44947962 bill.heaps@strataenergy.co.nz robert.reilly@strataenergy.co.nz While Strata Energy Ltd has used reasonable endeavours to ensure the information in this presentation is as accurate as practicable, Strata Energy, its contributors, employees, and directors shall not be liable (whether in contract, tort (including negligence), equity or on any other basis) for any loss or damage sustained by any person relying on the information contained in this presentation, whatever the cause of such loss or damage. The importance of new entrants in the New Zealand electricity market Paper to the 8th Annual New Zealand Energy Summit 17th July 2006 Presented by: Bill Heaps – Strata Energy Simon Hope - NZIER July 2006 In association with:

2. 2 Contents  The role of new entrants and their relevance to the NZ electricity market  The potential for new entrant generation  Channels for selling output from independent generation  Barriers to market entry  Role of independent retailers, brokers and aggregators  Summary

3. 3 Role of new entrants  Innovation  Increased consumer choice and discipline on quality  Discipline on prices  Increased efficiency  Reduced regulation  Additional employment opportunities What is the relevance of each of the above benefits to the NZ electricity market?

4. 4 Context – NZ energy supply situation  New Zealand’s energy markets are or are becoming constrained  Electricity (primary energy, generation, transmission, distribution)  Gas (exploration and supply, transmission, distribution)  Oil (production, refining, transmission, distribution)  Forecasts  2006 – 2010 prices strengthen as constraints appear and concerns rise  2010 – 2015 significant risk of supply curtailment and constraints if infrastructure investments have not been made  Carbon emissions controls may compound the situation  Consenting and approval processes make difficulties for infrastructure investments

5. 5 Context – Supply and value chains  Traditional supply chains may struggle to meet demand and environmental objectives  The need for innovation and investment in non-traditional energy supply and demand management will increase  Aggregation and facilitation service providers will be needed to establish capability for smaller players to enter energy markets  New energy efficient products and services will be developed and marketed  The value chain will flow in both directions  (supply – demand – supply)

6. 6 Context – One perspective of the current supply chain Traditional Energy Producers Wholesale Retail Demand  Supply to demand flow - no return path  Little demand response and participation  Barriers to smaller independent suppliers  Lack of liquidity, minimal innovation and inefficient use of resources

7. 7 Characteristics of existing players  They have both generation and retail businesses  They have multiple generation assets at different locations  Their retail customer bases tend to be located close to their generation (e.g. Meridian Energy dominant in the South Island, Mighty River Power dominant in Auckland)  They have large retail bases providing economies of scale  They are large enough to have wholesale and retail market obligations through their own resources  They sell their output through a portfolio of hedge contracts and wholesale spot market.

8. 8 Characteristics of potential new entrants  They are likely to be stand alone generators without retail capability  They will have generation assets at a single location  They may need to sell their output to customers remote from the physical location of the generator  They may have no retail base to provide hedging and will find it hard to create one with economies of scale  They may be too small to have internal resources sufficient to manage the wholesale and retail market obligations  They may seek to sell their output through a single long term contract.

9. 9 Channels to market 1.Offering output to the existing major generators 2.Selling to major users 3.Selling on the spot market 4.Selling via mass retail  The paper provides a view on the relative advantages and disadvantages of each channel.  Large generator/retailers use a combination of all channels  Independent single generators tend to access only option 1

10. 10 Barriers to entry  Technical  Scale, reliability, location, availability, intermittency,  Impact on system quality compliance with network connection requirements  System constraints and capacity availability  Market  Costs of being a market participant  Retail scale economies  Fuel supply uncertainty  Prudential risk management  Nodal price risks  Regulatory  Compliance  Exemption applications  Levies and other charges  Standards and technical requirements  Uncertainty

11. 11 Market charges (2005 base)

12. 12 Example 1 - 60MW unit generator only (North Island) Note: If the generator also retails then a share of ancillary services costs will be incurred

13. 13 Example 2 - 1MW unit generator only (North Island and South Island) Note: If the generator also retails then a share of ancillary services costs will be incurred

14. 14 The roll of independent retailers, brokers and aggregators There are two key barriers that prevent the emergence of retailers that are independent of major generators:  Hedge availability ‘to sell to customers you need hedge contracts – to get hedge contracts you need customers’  Wholesale/Retail margin

15. 15 Wholesale/Retail margin  Metering, meter reading and data management  Billing, debt collection and back office operations  Call centre costs  Complaints management and membership of an approved complaints system  Electricity Commission levies and EGR compliance  Marketing, customer acquisition and retention As an example, we have calculated that a retailer with 40MW base load hedge contract to sell in the upper North Island would need to service their customers at a cost below $150/year to breakeven. The $150 would need to cover:

16. 16 Brokers and aggregators  Wholesale market trading  Offer and dispatch  Prudential management  Market and price modelling  Transmission management  Call centre/customer service Aggregation is the action of combining many small components to gain the benefits of scale that are enjoyed by major players. Small distributed independent generators could be provided with common services via a broker/aggregator. Through an aggregation service, economies of scale may be realised via:  Metering and data management  Retail sales and marketing  Hedge contract balancing  Reconciliation  Invoicing and billing

17. 17 Summary  New Zealand’s electricity market is characterised by a small number of major generator/retailers with few smaller new entrants in both generation and retail  New Zealand’s electricity market was designed around large scale participants. Simple connection and market participation arrangements for smaller players do not exist. The complexity and cost of compliance with the market arrangements makes it difficult for new entrants to gain sufficient economies of scale to cover market entry costs.  Aggregation of smaller generation projects and retail services may emerge to provide new entrants with the opportunity to access the wholesale market and retail customers yet remain independent. The emergence of aggregators may depend on the development of market arrangements that enable the full benefits of distributed generation and demand response to be channelled to those that provide them.

18. 18 Questions???