1. Winter 2008 – a Meridian Perspective Aug 2009

2. Winter 2008 – What Happened? Winter 2008 was another stressful supply-side period for the NZ electricity industry, primarily driven by very low inflows over the Nov-07 to Jun-08 period: –NZ received 80% of average inflows (a ‘loss’ of 3,700GWh) over an 8 month period. Following on from the events of winter 2008 and in particular in the wake of the EC’s Winter Review there has been a great deal of public scrutiny and associated commentary as to what occurred and why. However the general quality of the debate has been poor, often contradictory, and largely anecdotal in nature: –Market prices should have been higher –Reservoirs were mismanaged –Commercial objectives were pursued ahead of national interests –Costs were unfairly avoided by generators and passed-on to consumers But as long as the debate and associated policy deliberations are conducted in an informed and impartial manner Meridian encourages a quality public discussion in answering: “Is the electricity market delivering a fair deal for NZ?” 1

3. Winter 2008 – A Hind-casting Exercise What is an appropriate metric to use in measuring the actions of the market? –This metric should judge behaviour from the perspective of what is best for NZ. To examine the events of winter 2008 we use the Spectra model configured to reflect the fundamental costs underlying electricity supply and demand in NZ: –Spectra is a SDDP model that balances the costs of excess thermal fuel burn against the costs of excess shortage in the face of uncertain hydro inflows to minimise the overall (supply) cost to NZ. –This approach is consistent with the short-run marginal cost (SRMC) of the system. –This is NOT a re-litigation of Meridian’s operational decisions on the day – rather we are using Spectra in the role of a proxy ‘regulatory benchmark’. We update the model for events that characterise the Jul2007-Dec2008 period: –Start storage conditions as at Jul2007 –Inflows and wind –Geothermal and co-generation output –Thermal outages (POCP) –NI and SI demand –Link configuration All the model is now solving for is unknown future hydrology Beginning in Jul2007: –First: optimise the use of water in storage in the face of the historical hydrological uncertainty – ie all weekly flows over the 1931-2008 period. –Second: run the model to simulate the 19 month Jul-2007 to Jan-2009 period for all hydrological sequences. –Thirdly: examine the inflow ‘sequence’ that corresponds to the Jul07-Dec08 period. Now examine how the modelled benchmark results compare to market outcomes. 2

4. Winter 2008 – A Comparison of Storage Levels Lowest inflows on record over Nov07-Jun08: -20% (3,500GWh) below average NZ inflows -23% (2,200GWh) below average MEL inflows 3

5. Winter 2008 – A Comparison of Market Prices 4

6. Winter 2008 – Comparison of Market Outcomes Market outcomes over the Jul-2007 to Jan-2009 period are very similar to those suggested by the model: –Market prices, generation, DC transfers, demand response, reservoir spill, and reservoir management all track very closely with what actually occurred. Answering some specific questions: –Should market prices have been higher? Marginally perhaps but in general no. –Did Meridian draw down its reservoirs to protect its own commercial position? No – lake levels largely followed inflows. –Did the thermals behave themselves? In aggregate yes. –Was security of supply threatened? No – or no more than it would have been under ECNZ. –Did Meridian ‘pass on’ high prices to consumers? No – MEL lost $125M over the winter 2008 period. Market outcomes in winter 2008 were determined almost entirely by environmental factors and NOT by undesirable behaviours. –It’s all about the inflows! –The market was a pretty good (but not perfect) reflection of a centrally controlled benchmark While we can successfully explain (and defend) what happened in winter 2008 this does not answer the bigger question of whether or not this is an outcome that NZ is happy with in the future. 5

7. 2000-2008 The Wolak Years

8. 2000-2008 Hindcasting: A Comparison of Waitaki Storage 6

9. 2000-2008 Hindcasting: A Comparison of Market Prices 7

10. SRMC Sensitivity Results The definition of thermal SRMC makes a large difference to the conclusion that market prices have prevailingly been higher than they should have been. An alternative thermal SRMC definition can lead to entirely the opposite conclusion. The definition of hydro SRMC makes a lesser but still significant difference to the conclusion that market prices have prevailingly been higher than they should. Physical storage outcomes are robust to any reasonable definition of hydro and thermal SRMC. The lack of internal consistency in regards physical and pricing outcomes can be seen in Wolak’s approach when security of supply is severally compromised. These sensitivities should not be interpreted as “Wolak may be right” rather they should be seen as: –A demonstration of “garbage in garbage out”. –A demonstration of the inherent noise in the estimation of fair market outcomes. 8

11. Additional Winter 2008 Material

12. Winter 2008 – Some Sensitivities We examine a range of “what-if’ outcomes over the 19 month period via sensitivities to the baseline hind-casting assumptions. Leaving aside issues related to the pricing of SI reserves, the HVDC has only mild impacts: –Storage trajectories over 2007-2008 are largely unaffected by changes in either assumed link size or additional water in storage at the start of the period leading up to the HVDC decommissioning in Spring 2007. –However a larger link would have driven lower market prices and reduced levels of spill in early 2009. National shortage costs can have large impacts on all aspects of system operation: –2008 appeared to operate to somewhere between a $2,500 and $5,000/MWh VoLL. –A higher VoLL could have significantly increased minimum reservoir levels (by up to 500GWh) BUT at the expensive of an enormous increase in marginal market prices as well as large increases in reservoir spill. –Given that no actual shortage occurred in 2008 it is questionable whether these additional costs are in NZ’s best interests. Thermal behaviours have large pricing impacts: –More benevolent thermal behaviour over the 2007-2008 period would not have significantly changed any of the physical outcomes, but could have made the delivery of the same physical outcome significantly cheaper. Dry inflow assumptions mimic higher VoLL assumptions: –Always assuming drier operating conditions for reservoir management has clear impacts for 2007-2008 and would have raised minimum reservoir levels. –However taken to extremes, while large increases in storage levels could be achieved this comes at the expense of enormous increases in marginal market prices and levels of reservoir spill. 9

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