The Future Is Bright for Our Renewable Electricity Sector 

Energy demand and consumption is one of the most interesting investment areas globally. There are a number of aspects to energy that mean it is important to have a clear investment view on trends. Energy issues are at the forefront of technological disruptions, carbon emissions, climate change, regulatory and consumer behaviour. In New Zealand the listed electricity sector is also a big part of our stock market, comprising 15.3% of the S&P/NZX50 index.

The new New Zealand coalition government has announced that it intends to conduct a “full scale review into power pricing”. In 2014 the Labour party strongly promoted a centralised model for the New Zealand electricity market but appears to have backed away from this stance, although their current preferred model is unclear.

On a recent trip to the US, to look at a number of different sectors (including healthcare, building, media and technology), one of our portfolio managers spent a week in Silicon Valley focussing on electric utilities and the lessons that can be learned for the New Zealand market.

Following the Energy Crisis in 2001, and the associated large-scale blackouts and corporate bankruptcies, the State of California prioritised energy efficiency and conservation, but have also remained tightly regulated and give consumers little choice.  Energy efficiency is encouraged by the use of a tiered tariff structure where consumers pay around 20c/kWh for normal household usage (very similar to New Zealand prices), but the rate quickly doubles if usage is more than the average household.  This has created a large incentive for consumers to conserve electricity (using demand management devices or installing batteries) or to seek alternative electricity sources where possible.  

As a result residential rooftop solar has been a popular choice, supported by Federal tax breaks, and the California Solar Initiative, a cash back scheme to encourage the move to clean energy.  Clean energy is a focus for California, because around 75% of electricity generation still comes from non-renewable sources such as gas and coal (California is intent on being a leader in US clean energy and by 2020 plans to have at least 33% of its electricity from renewable sources moving to 50% by 2030 excluding large scale hydro).  Along with the growth in residential solar, the number of large scale solar farms has increased substantially, so that solar generation is now around 10% of electricity production.  

In a tightly regulated inflexible market like California, this has caused a number of problems, one of which is wholesale electricity prices of zero during the day when the sun is shining and solar electricity production is high.  Because electricity retailers currently have to buy the electricity produced from residential solar at the retail price, they pay 20 cents for something worth zero.  Ultimately, the consumer has to pay more for their electricity anyway, because the regulated utility has a guaranteed regulated rate of return, and they are allowed to increase overall prices to achieve this.  This is forcing regulatory changes with a move to wholesale not retail prices underway, which is then undermining solar installation economics.

Another issue that utilities are grappling with is how to deal with growth in electric vehicles.  Several uncertainties remain, including affordability (battery prices need to decline from their current levels for electric vehicles to achieve cost parity with internal combustion engine vehicles), funding (who pays for the infrastructure required to charge the fleet) and policy (most governments have been very supportive of early adoption, but this is changing as governments struggle with a cost that can be up to 5% of tax revenues in many OECD countries).  Whatever your view is on the timing of the uptake of electric vehicles, in time there is a requirement for more transformers, fast chargers, upgrades to existing electricity lines in addition to new connections, and investment in software/technology to allow the system to communicate with the much larger number of participants. All of this has to be funded by someone. For the infrastructure development, there are some novel models developing from companies such as ChargePoint, a manufacturer of charging systems and software, where retailers are choosing to purchase the charging systems, offer convenient (and often prominent) parking spots and sell discounted electricity to drive foot traffic and promote their brand.  It is difficult however to see this happening at scale.

Unsurprisingly, given the scale and pace of change, and two clear trends of decarbonisation and customer choice, talk has turned back to the deregulation of California’s electricity markets with Michael Picker, the head of the California Public Utility Commission, calling for deregulation of the state’s retail electricity market.

What are the takeaways for New Zealand’s electricity sector?  Firstly, we are very fortunate to have 85% of our electricity production coming from large scale renewable generation.  We are much further along the path to decarbonisation than other countries, and there is no reason why (with the appropriate level of peaking capacity) we cannot move the percentage of renewables higher.  If we are genuine, as a country, about reducing carbon emissions, then transport (the source of roughly half of our carbon emissions) is one of the only ways to tackle the problem.  Encouraging electric vehicle uptake makes sense with our (largely) carbon free electricity.  This is not the case in many other countries such as Australia (as over there the electricity is generated by carbon emitting coal power stations).

Secondly, as shown by The Californian Energy Crisis, deregulation is sometimes not easy, and we have achieved an enviable balance between consumer choice (our energy retailers and generation companies operate in an unregulated competitive market with a high level of consumer switching), and the necessary regulation of the monopoly transmission and distribution companies.

With this in mind, the new government’s promise to “hold a full-scale review into retail power pricing” misses the bigger picture in our view.  The sector is going through major change, and what we really need is a co-ordinated approach that considers not only electricity prices, but the generation, transmission and distribution of electricity, whether we want to incentivise electric vehicle uptake, and who pays for the substantial infrastructure investments that will be required.

We believe that the listed electricity stocks in New Zealand are well supported by valuation and we continue to own Contact Energy and Meridian.