The rules defining the New Zealand electricity market trading arrangements are recognized as among the most advanced and successful in the world. Historically, these arrangements have induced sufficient generating capacity. However, the New Zealand electricity system is hydro-dominated, and commercial entities do not seem prepared to make investments in thermal generation that would only be useful in rare and unpredictable years of extremely low rainfall. The potential for market failure in these dry years requires attention and amendments to be made to the trading arrangements. The Government of New Zealand (“the Government”) recently prepared a discussion paper on generation reserves, which outlines a dry-year reserve policy proposal. Contact Energy Ltd. commissioned NERA to respond to the Government’s discussion paper and specifically to evaluate the Government’s dry-year generation reserve policy proposal.

In the report written in response, NERA describes criteria useful to such an evaluation and specifies the elements required to define an economically efficient dry-year generation reserve policy. The report analyzes the Government’s proposal against those criteria and examines how to develop and refine the proposal to better meet the criteria. The report concludes that the Government’s proposal is a suitable response to the dry-year generation concerns and that the policy principles put forward by the Government can lead to a method that will solve the dry-year problem with a minimum distortion on the market. However, NERA also suggests three enhancements to the plan, designed to address five areas of potential flaws with the Government’s proposal.