Critics warn Lake Onslow power scheme’s $4b price tag may balloon

Thursday, 17 February 2022

Electricity Authority chairwoman Nicki Crauford and then chief executive James Stevenson-Wallace give evidence to a select committee on February 10.

Critics of the proposed Lake Onslow pumped hydro scheme are talking up its costs and warning of a possible blow-out to its speculated $4 billion price tag, even before a decision is made on whether to proceed with the project.

But a dam safety expert says the detailed engineering investigations planned by the Government should reduce the risk of any surprises if the verdict comes back positive.

Dan Forster, chairman of the New Zealand Society on Large Dams, says the cost of the potential project is likely to be highly dependent on the outcome of geological investigations now underway.

A big factor would be whether local materials could be used to build the hydro schemes’ dams, or whether clay and rock would need to be trucked in.

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The Lake Onslow scheme would serve as a giant battery to help protect against hydro shortages during drought years and to, in effect, store highly-variable wind and solar generation for when it was needed.

Enough water could be pumped uphill into its reservoir in a natural schist rock basin high in Central Otago to provide power equivalent to somewhere between five and 15 weeks’ worth of the entire country’s electricity demand, depending on its configuration.

The Ministry of Business, Innovation and Employment (MBIE) has said early estimates indicate “a project like Lake Onslow” could cost about $4b and that its feasibility studies will provide greater certainty.

Energy Minister Megan Woods does not appear to have learnt anything from the investigations done so far that looks likely stop the pumped hydro scheme in its tracks.

Trevor Matuschka, director of consultant Engineering Geology and the immediate past chairman of the Society on Large Dams, says pumped hydro schemes are becoming more common around the world as generators shift from burning coal and gas to weather-dependent renewables.

There are more than 40 such schemes in the United States alone, and Matuschka says pumped hydro has gained traction over the past 10 to 15 years.

The British-based International Hydropower Association estimated in 2018 that generation from pumped hydro-schemes would grow another 50 per cent by 2030.

“There's a lot of experience and expertise in these types of projects. It's not as if we're trying something new that no-one else has tried,” Matuschka says.

Lake Onslow would be not be unusual internationally in terms of its expected maximum power output of about 1200 megawatts, which is equal to about 12 per cent of the country’s peak generating capacity.

But it might be unprecedented globally in terms of the amount of power it would store at a relatively low price, according to the International Hydropower Association’s figures.

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One of the nearest comparisons is Australia’s ‘Snowy Mountains 2.0’ pumped hydro scheme.

It will produce up to 2000MW when drawing down power, but is now expected to cost more than A$5b (NZ$5.4b) and would hold 350 gigawatt-hours of power, which would be less than a tenth of the expected power storage of Lake Onslow.

There is still plenty of water to flow under the bridge.

The Government doesn’t expect to be in a position to make a final call on whether to press ahead with a detailed business case for the project until December.

After committing $30m for an initial business case, the Government awarded an $11.5m contract for initial fieldwork in October.

It expects to commit a further $70m to technical investigations and design work next year, if it does proceed to a detailed business case, before making a final investment decision.

But as MBIE’s early investigations have progressed without apparently uncovering any show-stoppers and spikes in the wholesale price of power have continued to alarm big businesses, proponents of the scheme have become more hopeful it will get the green light and opponents increasingly afraid.

By acting as a huge energy store, Lake Onslow could allow NZ to produce much more power from weather-dependent renewables.

There is no sign Energy Minister Megan Woods’ optimism has been dented by anything the Government has learnt from the preparatory work done so far.

Instead, the Government is understood to view the viability of Lake Onslow as central to its aspiration of achieving 100 per cent renewable generation by 2030.

National Party energy spokesman Stuart Smith has voiced concerns about the risk of a cost blow-out if the project does go ahead.

“We only have to look at Transmission Gully to see that there is no such thing as a fixed-price contract even if it is intended to be,” he says.

Forster, who is also the general manager of Meridian Energy subsidiary Dam Safety Intelligence, says “construction projects, all over the world, always cost more money than people think”.

“Every dam is unique. Dams are a bit like people, they've all got their environment that they exist in, as well as how they have been designed and built.”

But he describes the hefty sums the Government has committed and earmarked for feasibility studies as “a promising sign”.

The success of such projects is typically proportional to the upfront effort that is put in, Forster says.

“It's a project that's being carefully thought through. That's evident from the amount of funding that's being invested.

“If you draw an analogy with a building house, it’s smart to understand the foundations that you're going to build the house on.

“You might do the bare minimum and hope for the best, but you could be in for a really nasty surprise, so often it's a false economy.”

The ground conditions at Lake Onslow would be important, in part because they would determine what foundations were required for its dam walls, but also because good materials would be needed “ideally on site or not too far away” to build the dams, he says.

“If you get either or both of those assumptions wrong, you can pay very dearly when it comes to actually finalising the design and build.

“What you don't want is a situation where you're quarrying and trucking rock, clay or aggregate from a source that's 50 or 100 kilometres away, as the construction costs ratchet up really quickly.”

Meridian Energy commissioned research that painted Lake Onslow as an expensive option.

Waikato University professor Earl Bardsley, who first identified the potential of Lake Onslow, says the schist rock at the site “is not as good as the Manapouri tunnel rock so will probably need sealing”.

“But pumped storage schemes have been constructed in schist,” he says.

Matuschka agrees that, literally, sound foundations for the investment would be key.

“You might go through two or three levels of investigations in increasing detail narrowing down the costs.

“There's often a lot of uncertainty in the early stages of a project as to how much treatment is required of the foundations.”

He believes that, at the moment, there isn’t enough information for anyone to arrive at “a truly informed opinion” on Lake Onslow’s viability.

But given there is a great deal at stake for the major generators in the outcome of the investigations and the Government’s decision, that hasn’t kept a lid on all debate.

National Party energy spokesman Stuart Smith suspects a tentative $4 billion price tag on Lake Onslow would prove to be an underestimate.

Enerlytica energy analyst John Kidd said in 2020 that Lake Onslow would “turn the electricity market on its head”, describing it as a 1000-pound gorilla that had the potential to impose a “hard ceiling” to wholesale electricity prices.

Meridian and Contact Energy got a jab in early, in November, when they released research they commissioned from consultant Concept Consulting that painted Lake Onslow as an expensive option that would need to generate annual revenues of $335m to justify its cost.

Woods, in turn, accused big power companies of sniping at the scheme out of their own commercial self-interest.

Concept Consulting’s study used MBIE’s $4b tentative cost estimate as the starting point for its calculation and assumed Lake Onslow would also cost $15m a year to operate.

It also assumed that the hydro lake would take five years to build and two years to fill with water, meaning it wouldn’t generate any revenues during that time.

And it assumed that the cost of building Onslow should be recouped over a 60-year period using a 6 per cent pre-tax, real cost of capital.

The dollar-figures resulting from such calculations are highly sensitive to that discount rate.

Concept Consulting director Simon Coates says it settled on a pre-tax return of 6 per cent based on Treasury advice that public sector agencies use a “5 or 6 per cent” rate of return when they conduct cost-benefit studies into proposed investments.

The Treasury’s current advice is that agencies use a 5 per cent rate for infrastructure investments, including energy projects, which Coates accepts would drop its own $335m annual break-even calculation to $278m.

Treasury spokesman Bryan McDaniel notes that the Treasury suggests agencies also use a 2 per cent rate for “sensitivity analysis”.

“As indicated in the guidance on our website, agencies may have grounds for using a different rate. In general the standard rates are to be used for comparability,” he says.

Certainly, there is no suggestion the Government would need to pay interest at either 5 or 6 per cent to borrow money to build Lake Onslow.

The Treasury raised $3b in September by issuing 30-year bonds that paid a yield-to-maturity of just 2.86 per cent, for example.

But its approach to cost-benefit analyses is designed to reflect the idea that if workers and machines weren’t being engaged on government projects, they might be profitably employed doing other work in the private sector.

In practice, the actual opportunity cost of the scheme would hinge in part on whether there happened to be strong demand for construction industry resources and labour during the period Onslow was built.

Matuschka says the price of fuel at the time would also be relevant.

“Earthmoving costs can vary a lot depending on fuel costs. You can imagine these big excavators and trucks burn a lot of fuel.”

While the Government could remove many financial risks by insisting on fixed-price construction contracts, that option would inevitably come at a price, he says.

“The more modern way of doing it is to have some kind of risk-sharing arrangement.”

Forster says the timescale over which the infrastructure would contribute to the economy would also be important.

“If you look at a lot of the hydro infrastructure that we've now got the benefit of if, if you were there on ‘day one’ when Muldoon proposed those ‘Think Big’ projects, you’d probably have gasped at the cost,” he says.

“But it's all about timescale. If you did the maths on it for the lifetime that we have had the benefit of those assets and what we're yet to gain from them, it’s a complex economics question.”