Australia’s energy focus should be on the prize, not the rules

It’s not worth getting too excited about the many technical deficiencies in the proposed National Energy Guarantee and the poverty of the vision that underlies it.

In the end it’s just a political thing to avoid having electricity or climate change targets as mainstream issues in the Federal election. Politically, both sides have had a win. Labor States will see that there weren’t any blackouts or high priced events this summer.

The Federal Government links high price or blackout events on Labor State environmental policies. We know this is wrong in fact, but it works politically.

On the other hand the NEG is progressing and if it is agreed to be implemented in September it will be seen as a wind for energy minister Josh Frydenberg and the Coalition, and will likely be in time to be a minor item for the next Federal election.

But the point is, it’s just a politics exercise. And even if wasn’t it still doesn’t pay to take your eye off the main issues.

The main issues are

1. If consumers, small and increasing bigger, continue to see behind the meter generation and or storage as cheaper than in front of the meter (utility scale) power, but still have the security of being connected to the grid, then behind the meter will keep growing at the expense of in front of the meter. If grid delivered volume is flat or declining it will be difficult to get unit costs and hence prices down.

2. Australia’s coal generators are getting old and in NSW particularly will have to be replace them over the next 10-15 years. If new supply is built in advance then reliability will be high but generators profits will suffer from oversupply for a while. If the new supply is built too late then there is a reliability/blackout risk and prices will for a while be sky high (see the Hazelwood/Portland smelter case study).

a) What will the LCOE be of the generation that replaces the coal fleet?

b) Will this make our electricity costs more or less competitive with our major trading partners? Lets say these are China, Japan and the USA

c) If most of the energy to replace the coal comes from the wind and the PV what will the technology(ies) be that provide the firming and how much of that firming generation is required?

Globally competitive industrial electricity. A prize to fight for

Here at ITK we are going to be spending a lot of time thinking about issue 2. Australia is going to have to have globally competitive electricity and it’s going to have to be done in a low carbon way.

Nor is it going to be enough to simply say that the rest of the world will eventually decarbonize. No way is that a good enough answer for industrial power consumers.

We need answers now and those answers require everyone in the electricity industry to pull together and to run over policitians and bureaucrats who don’t get it and aren’t on the bus. Stand up and be counted.

We are over the coal debate but here is a small refresher

Equally, building new coal power stations would be even more stupid. About as financially risky as building a nuclear power station.

And it would be environmentally destructive. The coal fuelled power stations would be financially risk because (i) its already environmentally difficult to get a new coal mine built in Eastern Australia, although there are a couple, (ii) old coal mines have increasingly expensive coal and (iii) it’s very clear that markets are pricing in global carbon risks and that discount is increasing.

The clearest financial evidence of this comes not from electricity markets or from any review of government policies around the world but from ordinary americans and the prices they pay for housing.

We covered the evidence from a survey of 480,000 (count them) housing transactions in the USA here at RenewEconomy before . Just to remind, the key points were:

• Properties exposed to projected sea level rise [SLR] sell at around a 7% discount relative to otherwise similar properties (e.g. same zip, time, distance to coast, elevation, bedrooms, property and owner type)

• The same discount does not exist in rental rates, indicating that this discount is due to expectations of future damage, not current property quality

• At the beginning of our sample in 2007 we find no significant difference between the prices of exposed and unexposed properties. By the end of our sample in 2016, exposed non-owner occupied properties are priced approximately 13.5% below comparable unexposed properties. In particular, we document increased transaction volume and lower prices for sophisticated buyers following the significant revisions of the IPCC’s 2013 release, which increased SLR projects and awareness

This study is very significant to us on several levels but the main point in this context is to demonstrate the financial risk of ignoring climate change.

Electricity company management will probably be better informed than the average home buyer about climate change but we expect that being better informed, and making investment decisions with similarly long time frames they are going to price in even more risk.

Even ignoring environmental risk from a straight economic point of view wind and pv will undercut coal fired and gas fired electricity on a variable cost basis whenever they operate, leaving the coal station struggling to get a return on few available operating hours.

A capacity payment from a Government could overcome this but most Governments are correctly going to be shy about making what is clearly a subsidy to support the old and dying thermal industry with no future as opposed to a subsidy to support the young and growing renewable future. A subsidy that is needed less and less.

So what policies should follow? What are the tasks?

1. Policies are required to spread the benefits and costs of distributed energy in such as way as to maximise the whole of society benfit and minimise its costs. I’ll get my hat and leave behind the meter for another time.

2. Policies are required to make sure that the new investment is built in advance of power stations closing. This requires compensation to electricity generators as they will make less money for a period of over supply, but it’s a lot less of a problem than running out of electricity.

a. Those new investment policies have to contemplate a realistic, that is a rapidly decarbonising, future.

b. More official research is needed to work out how much firming generation is going to be required at high levels of renewables penetration.. We have University studies from ANU (Blakers) and UNSW (Riez) but we need studies from the AEMC, from the ESB and from the AEMO so that everyone is on the same page about the way to make this transformation that minimises cost to consumers.

A start needs to be made on firming generation. I don’t think costs are going to come down much in the firming sector, pumped hydro is an old technology with site specific costs and carbon emitting gas is not going to double global installed capacity in a hurry.

This means learning rate impacts will be low and firming costs will remain high which is why we need to the system to minimise the quantity of firming required. Nevertheless

i. Some pumped hydro should be built now

ii. Probably some gas power should be built now in NSW. Fortunately it probably will be.

c. We think that there we should consider again whether energy markets are more appropriate than capacity markets. Here at ITK we have also supported energy markets but in the new world order its less clear. Consider that:

i. Wind & PV have zero short run marginal cost. So they are just dispatched as available and unless constrained. What is the point of an energy market for zero marginal cost supply?

ii. Dispatchable power is only required sometimes. Its nature means its more of a capacity rather than energy supplier. Therefore it should be paid for accordingly.

iii. Making dispatchable power and even wind and PV on a capacity basis will allow them to be built in advance of when they are needed. And that is what Australia is going to require over the next decade.

d. Liddell will be replaced mainly by wind & PV. Vales Point and then Eraring will be replaced mainly by wind & PV. Since a lot of wind & pv is going to be built we need policies that …

i. Keep the WACC (weighted average cost of capital) for this form of generation low. Revenue certainty is by far the best way of keeping the WACC down. Revenue certainty can be provided either by

1. PPA with high credit rating counterparty

2. Capacity payment

ii. Maximise the portfolio diversification benefit. If wind and PV can only provide 60% of the energy the total amount of firming required will mean the end price to consumers is higher than if wind & PV can provide 70-80%. So this means diversifying the wind & PV portfolio to minimise the covariance between the plant outputs.

iii. Make sure the transmission is available in renewable zones.

David Leitch is principal of ITK. He was formerly a Utility Analyst for leading investment banks over the past 30 years. The views expressed are his own. Please note our new section, Energy Markets, which will include analysis from Leitch on the energy markets and broader energy issues. And also note our live generation widget, and the APVI solar contribution.