2021 Draft Advice for Consultation Emissions Budgets

Climate Change Commission Via online form submission 26 March 2021

2021 Draft Advice for Consultation

Emissions Budgets

Mercury welcomes and supports the Climate Change Commission s landmark draft advice which builds on the important work of its predecessor the Interim Climate Change Committee (ICCC). The draft advice sets a clear pathway for emissions reductions and re-establishes Aotearoa New Zealand ambition to take meaningful action to meet its international commitments. Mercury commends the Commission s analysis which has challenged all sectors of the community, the economy and government to consider how to both realise the ambition, and to transition to a low carbon future that is inclusive, that supports the most vulnerable in society and recognises the unique perspectives of .

Aotearoa New Zealand must focus on material opportunities for decarbonisation The draft advice highlights the critical role the renewable electricity sector will play in ensuring Aotearoa New Zealand transitions to a low carbon future. Demand for renewable electricity generation is expected to double in the period to 2050 as fossil fuels are replaced within the wider energy mix. Mercury strongly supports the Commission s view that an overarching energy strategy and renewable energy target is required. As the analysis notes, demand for renewable electricity will see very high levels of renewable electricity achieved while ensuring prices remain efficient and generally affordable and security of supply is maintained.

Mercury supports the recommendation for a national energy strategy and renewable energy target that focuses on ensuring that Aotearoa New Zealand maintains its world leading performance in managing the energy trilemma 1.

Critically an energy strategy needs to include multiple sectors and decision makers and deliver effective alignment across key policy mechanisms such as resource planning, local government decision making for renewables investment and support for long-term market signals across multiple political cycles.

Mercury fully supports the Commission's view that the most material opportunities for decarbonisation are in the substitution away from fossil fuels in the transport and process heat sectors. Households with an electric vehicle for example are estimated to save around $1000 per year on household energy costs. However, the major impediment to uptake remans the higher upfront capital costs of electric vehicles. To address this barrier, Mercury has invested in a flexible leasing program called Drive which enables households and businesses to benefit from the much lower running costs of electric vehicles.

Mercury supports complementary measures to the Emissions Trading Scheme (ETS) to support electric vehicle uptake, particularly around ensuring Aotearoa New Zealand has effective emission standards. Mercury endorses the recommendations from the recent Concept Consulting / Reytna report on measures to accelerated low emission vehicle uptake2 and considers the design of any incentives needs careful consideration to ensure they are truly complimentary and do not result in regressive outcomes for consumers.

1

https://www.worldenergy.org/publications/entry/world-energy-trilemma-index-2020

2

Shifting gear

`

How New Zealand can accelerate the uptake of low emissions vehicles (27 January 2021)

The Mercury Building, 33 Broadway, Newmarket 1023 PO Box 90399, Auckland 1142

PHONE: + 64 9 308 8200 + 64 9 308 8209 FAX:

mercury.co.nz

We must act with urgency, not wait for further analysis Since the draft report has been released there has been significant debate around the assumptions and the ability to make the necessary changes within the budget periods. While there has been concerns around the pace and rate of change, there has been no rejection of the urgent need for action. Invariably any modeling exercise will contain assumptions and information that in hindsight prove to be different from a future state. However, this should not prevent action as the science is clear - the more we delay the more expensive and difficult the transition will be in future. We must act with urgency and not delay by calling for further analysis which will only serve to increase the challenge ahead.

Markets are inherently well suited to dealing with complexity and uncertainty around future states of the world.

Electricity market participants for example must evaluate a diverse range of signals and uncertain information when considering new investments including electricity market prices, government policy, technology costs, future market structures, planning and environmental frameworks, the needs of the wide range of stakeholders within relevant communities and the ability to attract capital and deliver long-term sustainable outcomes.

Despite flat electricity demand, analysis from the ICCC in 2019 was a material factor alongside the decreasing costs of wind generation, in Mercury announcing it would build Aotearoa s largest wind farm at Turitea, near Palmerston North. The clear signal from the ICCC analysis was that significant investment in new renewable generation would be required to to decarbonise the economy. Further clarity around the future of the Tiwai aluminum smelter has led to additional investments across the sector being announced. Currently investments equivalent to 8% of Aotearoa New Zealand's annual generation have either been commissioned or are in the process of commitment representing a value of around $1.8bn with a further 1.3bn awaiting financial close (see Box 1).

Box 1: Recent renewable generation investment made in New Zealand Capacity / Company Project Investment Energy Tilt (Genesis Waipipi (Wind) 133 MW $277m PPA)1 Top Energy2 Ngawha OEC4 (Geothermal) Extra 32 MW $185m Mercury3 Contact4

Turitea (Wind) Tauhara stage 1 (Geothermal)

222 MW 153 MW

$464m $580m

Meridian5

Harapaki (Wind)

176 MW

$395m

~ 700 MW

~ $1.8b

Other projects awaiting financial close MainPower6 Mt Cass (Wind)

93 MW

$200m

Contact7

TOTAL COMMISIONED AND COMMITTED:

Tilt Renewables8 Top Energy9

Wairakei replacement and expansion (Geothermal) Tararua repowering (Wind)

Extra 70 MW

$700m

Extra 72 MW

$250m

Ngawha OEC5 (Geothermal) NEAR TERM POTENTIAL:

Extra 32 MW ~ 260 MW

$185m (est.) ~ $1.3b (est.)

Notes Commissioned Nov 2020 Commissioned Dec 2020 In construction Committed, expected mid-2023 Committed, expected 2024

Preliminary works underway Upgrade of existing geothermal station Capacity upgrade of existing windfarm

Sources: 1 Tilt Renewables, Waipipi Wind Farm, available from www.tiltrenewables.com 2 Top Energy Our New Geothermal Power Station Is Live! 27 January 2021 3 4

www.nzx.com www.nzx.com

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Meridian Energy, 2021 Interim Results Presentation, from www.nzx.com https://www.scoop.co.nz/stories/AK1912/S00472/work-to-start-on-mt-cass-windfarm.htm 7 Contact Energy, www.nzx.com 8 18 February 2020 6

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The outlook for further investment is highly positive with enough renewable generation consented to cover the demand from the entire light transport fleet. Figure 1 on the follow page details the current consented renewables pipeline with those developments that have been announced or are currently under construction.

Figure 1: Consented and Commissioned Generation Development

Total available renewable generation (consented and committed) is enough to meet demand from the entire light vehicle fleet.

The market is delivering new renewable generation equivalent to 8% of annual demand

Source: Electricity Authority

Electricity Market Information, Mercury

Mercury's has further wind development options in its Puketoi windfarm with consent for a further 53 turbines and the recent acquisition of the domestic assets from Tilt Renewables (subject to Tilt shareholder and regulatory approvals) includes a development pipeline equivalent to a further ~4% of national demand. In addition to large scale generation investment, innovation is flourishing with new business models emerging in areas such as distributed storage and generation, alternative transport technologies and research into the potential future domestic applications for green hydrogen and e-fuels.

The electricity sector will deliver emissions reductions with the right policy settings Mercury considers that the current electricity market policy settings are sending the right signals for investment in new renewable electricity generation.

The electricity market has already delivered Aotearoa . Figure 2 illustrates how electricity generation from thermal fuel has fallen significantly since its peak in 2008. This was primarily driven by significant investment in renewable geothermal generation which increased from around 7% in 2000 to 17% of generation in 2018 along with the retirement of relatively more expensive thermal generators and a quadrupling of the contribution from all other renewable sources (primarily wind).

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Due to flat demand growth between 2006 to 2013 and the resulting reduction in wholesale prices, a rebalancing of supply occurred with the efficient retirement in 2015 of around 450MW of thermal gas-fired generation in Auckland by both Mercury and Contact Energy. This permanently removed 2 million tonnes per annum from New carbon emissions, equivalent to entire annual emissions of the aviation sector in Aotearoa New Zealand. Mercury is not aware of any larger contribution to reducing emissions from any sector over this period.

Most importantly, this occurred through the market without the need for any government intervention and without any costs or risks to New Zealand tax payers.

The significant strength of the New Zealand electricity market has been the commitment by successive governments to avoid picking technological winners via distortionary interventions like subsidies or bans 3. This has allowed New Zealand to develop a diverse and complimentary mix of renewable and non-renewable generation leading performance in balancing the energy trilemma.

Looking forward the main emissions reductions opportunities for Aotearoa New Zealand will not come directly from the electricity sector, which is already highly renewable, but rather from other sectors of the economy including transport and process heat. Mercury considers the most effective approach is to ensure that the current market settings are supported and targeted policies are implemented for these sectors to stimulate demand.

Mercury agrees with the Commission that in the future the electricity sector will need to fully decarbonise, but the timing and sequence of the transition is critical. The Commission's modeling shows that flexible gas supplies will be required beyond the 2030 target for . Maintaining gas in the system is likely to be the least cost and most efficient way to deliver emissions abatement across the economy.

Without an appropriately managed transition for fossil fuels from the electricity system Aotearoa New Zealand runs the risk of perversely increasing emissions to ensure security of supply (as is currently occurring with the increase in coal generation due to the shortage of gas supplies) or raising electricity prices and delaying the transition of the transport and process heat sectors to renewable electricity and alternative fuels.

Mercury acknowledges that as the penetration of renewable electricity generation increases there will be a need to ensure that the market continues to adapt and is flexible to change. This is particularly the case as the sector retires thermal generation which currently plays an important role in signaling the marginal cost of generation for future investment. This will include consideration of options for the managed transition for thermal fuels, how any dry year storage options may integrate into the market and the implications from any long-term increases in decentralised generation. Mercury supports the government, regulators, industry and consumer representatives working collaboratively to on any market adjustments that may be required.

Suggested actions to support the renewables development pipeline To achieve electrification of the economy in the timelines contemplated by the Commission there will need to be strong government policy support. Legislative change is both contemplated and necessary to reform the Resource Management Act and replace it with a National and Built Environment Act (NBA) and create a new Strategic Planning Act. The NBA needs to expressly reference the climate system and its biophysical limits and outcomes and afford them priority over competing biophysical limits and outcomes. Without this high level prioritisation consenting and building the renewable electricity generation and transmission projects quickly enough to meet the proposed emission budgets and plans will be challenged. We attach for the Commission Role of a Reformed Electricity Sector Environment Group along with associated case studies. The paper contains suggestions drafting for the NBA. Wind farm development and commissioning processes currently rely heavily on external contractors who operate in global markets. Commissioning expertise is generally not held domestically but operates on a -in Flyat key stages of the process. Given the long-term development pipeline for wind generation in Aotearoa New Zealand, there are opportunities to increase the skills and training in windfarm commissioning processes among the domestic workforce. Mercury supports the industry and government working collaboratively on an industry skills and training plan to provide future job opportunities to New Zealanders and support regional economic development. This should be progressed independently of the proposed national energy strategy as a priority but could usefully form part of that process as it is delivered.

3

Refer https://nzinitiative.org.nz/reports-and-media/reports/switched-on-achieving-a-green-affordable-and-reliable-energy-future/

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Energy storage options should support market signals and long-term investment Mercury supports the Commission's view that meeting Aotearoa New Zealand 2030 and 2050 emissions reductions targets requires a long-term view of investments and infrastructure developments. Investments being made now in new renewable generation and the refurbishing existing renewable generation will have asset lives that extend potentially even beyond 2050.

Given the size of the investment challenge in new renewable electricity it is imperative that the investment signals provided through the current market frameworks are maintained to give confidence to capital holders to continue to invest in the electricity sector. Ongoing uncertainty around the future of the Tiwai aluminium smelter for example and the impact that a disorderly exit would have on the market, has been a major impediment to renewables investment in the South Island and a major risk for institutions considering investment in Aotearoa New Zealand electricity sector.

Replacing the current role that fossil fuels play in providing dry year support in the electricity market during the transition to a low carbon economy is a key policy question currently under consideration by the government. The New Zealand Battery Project run by MBIE is considering the role particularly of pumped hydro storage options, including a large centralised scheme in the South Island at Lake Onslow estimated to cost around $4 billion.

Mercury agrees with the Commission that while a solution to the dry year challenge could enable the country to reach 100% renewable electricity, it could also cost taxpayers billions of dollars which would be better allocated to pursuing lower cost abatement options in other sectors. One key reason for the shift towards electricity market liberalisation was uneconomic generation investment outside of merit order by Government central planners. An investigation by Treasury in 1984 found unnecessary expenditure incurred on three power stations alone cost taxpayers up to $3 billion in 1983 dollars or the equivalent of more than $10 billion in three power stations were either not used at all (Marsden B) or only rarely (Whirinaki) 4.

This type of economic wastage has been eliminated by the competitive generation market we have today in Aotearoa New Zealand. Further, a large scale pumped hydro scheme would be a major intervention into the electricity market creating significant uncertainty and risk during a period where capital attraction to the sector is highly important if the country is to meet its decarbonisation goals. in the long-term to manage dry year risk. The New Zealand Battery Project will consider alternative options to a large scale centralised pumped storage option. This process will be critical to ensure that the least cost options are evaluated and that there is a credible assessment of the risks and opportunities from alternatives.

There are several North Island hydro storage options which could be developed that would not require pumping infrastructure and could integrate into the existing generation systems. These decentralised options could be developed relatively quickly as needed and at far lesser expense, reducing the risks to taxpayers and to existing market signals and investments. Developing storage in the North Island would also reduce the need for reserve generation to cover the risk of a potential failure of the interisland HVDC link. In addition to new storage, allowing greater range on existing hydro storage lakes to be used as contingent storage for dry year risk cover should be evaluated as a least cost option.

There is significant incentive on the wider electricity supply side of the industry to work collaboratively on a managed transition for fossil fuels out of the electricity sector. Energy security is the most important part of the energy trilemma and the critical success factor for the ongoing support of the current market arrangements. Cost sharing arrangements for the managed transition of existing thermal assets across market participants under a potential strategic reserve arrangement is just one example of an option that could be usefully explored under the Commission's proposed energy strategy and discussions could be facilitated by government under Commerce Act requirements.

4

NZ Treasur

and Government, 1984

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The role of carbon pricing and the impact on electricity prices and emissions reduction Mercury agrees with the Commission that the main driver of emissions reduction should be a broad-based carbon price provided by the ETS. Any non-price measures may be appropriate in instances where market or government failures are identified particularly where they relate to regulatory, informational and cost barriers. As noted earlier, a key example here is the lack of emissions standards for the vehicle fleet which could result in Aotearoa New Zealand becoming a dumping ground for high emissions vehicles from other countries if regulation is not made consistent with those jurisdictions.

There has been significant debate around the current high prices in the electricity market due to reduced hydrology and the impact of declining gas availability. Concerns have been raised around the potential impact of introducing higher carbon cost on the wholesale market prices and the potential consumer impacts. The Commission's analysis suggests that wholesale electricity prices will start to decline from new renewable generation, with key assumptions being the timing of the potential exit of Tiwai aluminum smelter and the demand for gas from Methanex, before rising again to about the same levels as present by 2035.

Mercury broadly agrees with the pattern of pricing in the Commission's analysis though the timing and extent may differ due to actual outcomes in the market. The Commission has indicated it intends to undertake sensitivity analysis to the wholesale market price path assumptions which Mercury supports. Due to the highly capitalintensive nature of large-scale infrastructure, generation and transmission investment tends to be very lumpy resulting in step changes in supply and capacity. While step changes are possible on the demand side, generally demand tends to be incremental. As outlined in Box 1, currently the supply side of the industry is in a significant investment phase with investments equivalent to around 8% of annual demand currently either commissioned or underway.

As new renewable electricity is deployed it will start to displace higher cost thermal generation and average wholesale prices will start to reflect the long run marginal costs of the cheaper renewable generation. This pattern is evident from the last phase of renewable geothermal generation expansion that occurred through the early 2000s as outlined in the chart below:

Source: ASX, WITS

High wholesale price signals through the early 2000s (under assumptions of increasing consumer demand) led to significant investment in geothermal generation as detailed in earlier sections. The above graph shows that this resulted in a significant period of much lower wholesale prices which also facilitated new entry of independent retailers.

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Recent MBIE data indicates that household electricity prices have been at the lowest level since 2012 despite the significant price increase in wholesale electricity market costs as outlined above 5. Mercury recognises however that high wholesale market prices currently are putting pressure on large energy users. The current wholesale market outcomes highlight the important role of gas in ensuring Aotearoa New Zealand maintains balance in the energy trilemma. However, Mercury is increasingly seeing opportunities for industry market participants to share risks through arrangements such as long-term Power Purchase Agreements an example being the proposal from the Major Energy Users Group to enter into long term offtake agreements for new renewable electricity generation.

Mercury s view is that the current renewable electricity generation build will deliver a step change in renewable electricity generation over the next few years while increases in new near-term demand are likely to remain linear which should increasingly be reflected in wholesale electricity prices. Mercury agrees with the longer-term assessment from the Commission that demand from transport electrification and process heat will be material which in our view is what is driving the current investment cycle.

Increasing carbon prices will be reflected in electricity wholesale market prices during periods where thermal plant remains marginal. However, this will serve to make thermal generation more expensive relative to cheaper renewable sources. As in the preceding investment phase, increasing new renewable electricity generation from baseload geothermal and variable wind sources will displace thermal generation. This will therefore reduce the periods with thermal generation is marginal. Mercury therefore expects that wholesale prices will reflect the lower costs of renewable generation on average but that greater volatility in wholesale prices will be expected over peak periods where thermal plant remains marginal.

Mercury agrees with the Commission that what is required is a focus on how energy use across the economy rather than just how the electricity sector alone should be decarbonised. While there has been much debate around the impact of carbon pricing on electricity prices the outlook for increased renewable electricity use in energy is for significant cost savings. Electricity prices, even reflective of the carbon price path estimated by the Commission, will not materially reduce the total average household energy cost savings of $1000p.a. from owning an electric vehicle for example. Higher carbon prices will also have a material impact on the economics of process heat conversion, accelerating emissions reductions in that sector Conclusions Mercury welcomes and supports the analysis from the Commission as part of its draft emissions budgets. We look forward to engaging constructively with government, industry stakeholders, regulators and consumers on a finalised plan and continuing to support Aotearoa New Zealand to achieve the emissions reductions commitments.

With the right focus on material opportunities and on maintaining and enhancing our existing market frameworks, Mercury is confident that we will collectively continue to deliver in the long-term on current world leading performance in balancing the energy security, energy equity and environmental sustainability limbs of the energy trilemma.

Yours sincerely

Nick Wilson Manager Government and Regulatory Affairs

https://www.mbie.govt.nz/building-and-energy/energy-and-natural-resources/energy-statistics-andmodelling/energy-statistics/energy-prices/electricity-cost-and-price-monitoring/

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