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.