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New Zealand’s energy sector is stalled by a supply-demand standoff, but there are ways to stimulate growth and attract investment.
In brief :
- While New Zealand’s energy supply side challenges capture headlines and headspace, the demand side of the equation is often overlooked.
- High electricity prices and recent policy shifts make it challenging to attract and retain industrial customers.
- Addressing the demand disconnect requires coordinated action from both government and market players so new generation is not just possible, but probable.
New Zealand’s electricity market has long operated under the assumption that demand will inevitably rise. According to the prevailing belief, by removing supply side barriers we will naturally see a surge in new generation projects to meet anticipated demand growth, smooth price volatility and keep us on track to net zero by 2050.
However, this narrative overlooks a crucial factor: the role of demand itself in stimulating new supply. The market cannot rely solely on the expectation of growing demand; it must be actively cultivated and supported by tangible commitments that can justify and finance new generation capacity.
In August, following a combination of a gas shortage and low inflows into the nation’s hydroelectric reservoirs, Prime Minister Christopher Luxon declared an “energy security crisis.” Volatile energy market conditions and the lack of depth of hedging markets have had swift and decisive impacts on industry operations. For some large energy users, this has proven to be the straw that has broken the camel's back, leading to several closures and threatening the long-term viability of others.
While the high prices seen in August could be argued to be the market sending the necessary price signals for investment in new capacity, it also hints at symptomatic, systemic issues within New Zealand’s energy sector.
If the price signal that is required to make an investment decision in new generation is the same as the price signal that is required to close down industrial consumers, then we are caught in a downwards spiral where nobody wins.
Supply and demand standoff
To meet net zero by 2050, the New Zealand Government has committed to double renewable energy generation while supporting the country’s long-term ‘energy resilience’.
The New Zealand Government has announced a series of energy market reviews that complement measures already underway, including a review of the electricity market’s performance and legislation to establish a framework for offshore wind farm development.
Importantly, the Electrifying New Zealand plan, released in August, outlines a series of reforms to make it easier and cheaper to consent, build and maintain renewable electricity generation.
But one core issue lies in a feedback loop where both supply and demand wait for the other to make the first move.
On one hand, new renewable generation projects require confidence that there will be enough demand, scale and a contracting market to justify investment decisions and improve competition. On the other hand, potential demand – whether that’s from data centres, electric vehicles or industrial processes – is stymied by the high cost and uncertainty of existing electricity supply.
Rather than ‘build it and they will come’ the current model is ‘come and we will build’. The challenge, however, is without competitive pricing, New Zealand will struggle to attract new industries or retain existing ones.
From peaks to plateaus
Aotearoa New Zealand's shift from an industrial and manufacturing-based economy to one centred around services has led to modest demand for electricity, compared to forecasts.
Data from the Ministry of Business, Innovation and Employment (MBIE) reveals that 60% of New Zealand’s electricity in 2023 was generated through hydropower, 18% through geothermal, 9% through gas, 7% through wind and just over 2% from coal.
The early 2010s saw an uptick in investment in renewable energy projects, particularly in geothermal assets. However, this momentum slowed when integrated utilities recognised that demand growth had plateaued, together with uncertainties regarding the closure of New Zealand’s large industrial facilities such as the Tiwai Point Aluminium Smelter. Faced with the risk that continued investment in new generation capacity amid flat demand could lead to lower wholesale electricity prices, these utilities became increasingly cautious about further expanding their generation portfolios.
MBIE expects total electricity demand to grow between 35.3% and 82% by 2050. In the short term, electrification in the commercial and industrial sectors is the main source of demand and is anticipated to drive this growth. From the late 2030s, electrification of transport is forecast to play a larger role with increased uptake of electric vehicles (EVs). The degree and timing of this switching of existing fossil fuel use to electricity is, as MBIE says, is a ‘key uncertainty’.
New Zealand total electricity demand forecast out to 2050
Source: MBIE, 2024.
While discussions around energy demand growth persist, actual increases remain elusive; however, the recent commitment by the New Zealand Aluminium Smelter to maintain long term operations at Tiwai will provide greater certainty over demand stability. Recent policy shifts, such as the Clean Car Discount for EVs and the Government Investment in Decarbonising Industry (GIDI) fund, are likely to further dampen anticipated growth in key sectors. Our challenge is to align current investments with the evolving needs of a decarbonised future.
Addressing the demand disconnect
Looking at examples from other countries can provide insight into potential solutions that bring forward new capacity to the market.
Power Purchase Agreements (PPAs) have provided long-term price stability in several international markets. While PPAs have been used by larger industrial players, such as NZAS, they haven’t gained significant traction in the commercial market. However, PPAs could play a much larger role in incentivising new supply and providing new and existing users with a viable hedging mechanism to manage exposure to price volatility.
On the supply side, there are interventions which can reassure energy users – both new and existing - that sufficient new generation will be available to support future demand.
In Australia, the Capacity Investment Scheme provides a backstop for new renewable projects, effectively reducing the risk for developers. The Australian Government is looking to deliver an additional 32 GW of capacity by 2030, by providing revenue underwriting for successful CIS tender projects and an agreed revenue ‘floor’ and ‘ceiling’ that derisks investment.
Similarly, the United Kingdom’s Contracts for Difference (CfD) scheme provides project developers with direct protection from volatile wholesale prices. Successful developers enter into a private law contract with the government-owned Low Carbon Contracts Company and are then paid a flat indexed rate for the electricity they produce over a 15-year period.
Meanwhile, there are increasing calls for more substantial disruption within Aotearoa’s electricity market.
Effective mechanisms exist in global markets that bring forward new capacity in an orderly fashion to supplement existing dispatchable generation. New mechanisms could advance New Zealand’s greenfield project pipeline while also contributing to the development of the commercial market.
Some voices advocate for a structural separation of retailing from generation, arguing that this could mirror the competition seen in the telecommunications sector following its separation. Proponents of this idea suggest that New Zealand could leverage its renewable energy resources to become a global leader by attracting data centres and other power-hungry industries. (We explore how New Zealand can power sustainable data centres while the world sleeps in our last thought leadership piece).
Other voices argue for a more hands-off approach, suggesting that flexibility will accommodate emerging technologies and innovative business models.
The ideal scenario is likely to be a collaborative effort where the government gives the market a nudge in the right direction and then steps back to allow market forces to take over.
The recent Government Policy Statement (GPS) makes it clear that the New Zealand Government's role is to create a stable environment that enables more private investment in generation. This is needed to support the nation-wide goal of doubling renewable electricity generation to meet the forecast increase in demand.
While getting the settings on the supply side is crucial, it is also important to shore up the demand side to ensure there is confidence needed to underwrite this new supply. Without addressing the market’s core issues, New Zealand risks falling behind in its energy transition goals.
Summary
The stakes are sky high: failing to act will not only keep electricity prices elevated for years to come, but also undermine the country’s renewable energy targets and economic growth prospects. Now is the time for all stakeholders – government, regulators and market players – to come together to craft a cohesive strategy that supports supply but actively stimulates and sustains demand.