The Australian Energy Market Operator (AEMO) is working through the sequence of events and will no doubt provide further information in the coming months.
" Renewables (and energy-efficiency) represent the only foreseeable way of materially reducing emissions in the electricity sector."
Dr Tim Nelson, AGL Energy & Griffith University
Much of the debate though has taken on a ‘renewables versus conventional’ tone. This is not the issue.
Australia has committed to reduce its emissions by between 26 per cent and 28 per cent of 2005 levels by 2030. To put this in perspective, the entire National Electricity Market (NEM) will need to have similar emissions intensity to South Australia today by 2030.
Some commentators have suggested we shouldn’t continue to support renewable energy specifically as it isn’t the ‘least-cost’ way of reducing emissions. However, such statements ignore the fact renewables (and energy-efficiency) represent the only foreseeable way of materially reducing emissions in the electricity sector.
The above chart presents the results of recent modelling by AGL which shows under a ‘least-cost’ approach renewables will need to grow substantially. This is due to the absence of cost-effective gas supplies (much of east-coast Australia’s large quantities of gas reserves are contracted for export).
Given renewables are required for Australia to hit its climate change targets, the next question for the Review is the nature of the transition. Relying solely on the market will produce ‘disorderly’ replacement of the capital stock.
Renewables are ‘intermittent’ in nature which means they only produce energy when the sun is shining or the wind is blowing. As more renewables are incentivised to come into the market there will be a need to replace the existing fleet of ‘firm’ generators which can be called upon when the wind isn’t blowing or the sun isn’t shining.
If left to the market alone, the transition will be disorderly. Around three-quarters of the existing thermal (coal and gas) power station fleet is beyond its original engineering design life.
As more renewables enter the market, existing generators will see their revenues fall as prices reflect both oversupply of energy and the very low short-run marginal cost of renewables (the wind and sun are free!).
Eventually, this will potentially lead to sudden loss of large volumes of ‘firm’ capacity (as happened in South Australia with the withdrawal of the coal-fired Northern power station) as generators go broke or break.
As new ‘firm’ capacity won’t be able to be built quickly enough to coincide with the sudden removal of the existing plant, the end result could be prolonged periods of low prices followed by a sudden shift to very high prices. This is obviously not in the interests of consumers, investors or the community.
There are two key ways this could be mitigated. Firstly, governments could introduce a policy requiring power stations to close at the end of their operational life.
This policy would allow for the orderly replacement of the capital stock and could be based upon age, emissions or a market based mechanism as proposed by ANU economists.
Secondly, it would be worth considering how to mitigate the unintended consequences of introducing renewables into the ‘energy-only’ market. New renewable investment policies could require renewable projects to staple a ‘firm capacity right’ to their projects.
In other words, each renewable power station would contract with a firm, flexible thermal plant to provide a ‘virtual power plant’ largely renewable but also ‘firm’ and can be called upon when needed.
On 19 August, Bluenotes published my thoughts on the case for electricity and climate change policy integration, with a particular focus on the South Australian market.
Since then, as a result of the blackout, the CoAG Energy Council has appointed Australia’s Chief Scientist Alan Finkel to conduct an independent review to develop a National Electricity Market blueprint.
It is very timely then to consider how the Review could address the ‘policy trilemna of: competitive pricing; reduced greenhouse gas emissions; and energy security.
There has been a lot of discussion about building greater interconnection, essentially the transmission lines between markets. I would urge policy makers to be careful because regulated assets lock in long-term costs to consumers.
In the 2000s, concerns around security of supply in NSW and Queensland resulted in policy makers shifting from ‘probabilistic risk-based’ electricity network planning to a ‘deterministic N– 1’ methodology for distribution networks.
The tightening of these standards led to a large increase in capital spending on electricity networks. Total network assets in these states more than doubled from $A27.6 billion to $A60.8 billion (see chart below for a contrast of network assets across the states). As network tariffs doubled, there is now discussion about ‘gold plating’ and ‘overspending’ on distribution network assets.
The Finkel review has a unique opportunity to reshape Australia’s energy policy and resolve the trilemma of security, competitiveness and reduced emissions.
In my view, these few simple ‘policy tweaks’ – generator closure rules; ‘firm’ capacity stapling to renewable investment policies; and a cautious approach to regulated infrastructure spending - could be introduced to provide medium-term investor confidence and better outcomes for consumers and the community.
Dr Tim Nelson is Head of Economics, Policy and Sustainability, AGL Energy and Adjunct Associate Professor at Griffith University. These are his personal views and do not represent the positions of either AGL or ANZ.
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
17 Oct 2016
07 Oct 2016
19 Aug 2016