Market insights

Australia’s skyrocketing power prices: How we got in this mess and how we could get out

09 May 2017

This article was first published in EcoGeneration on 8th May 2017

A paper prepared by Green Energy Markets explains that over the past two years Australia’s east coast National Electricity Market has experienced a profound, decisive and permanent unravelling of conditions that kept Australia’s east coast wholesale power prices low by international standards.

Contrary to conventional wisdom, the answer to reducing these prices is also the same answer to reducing emissions from Australia’s power supplies, which are the second most pollution-intensive in the developed world.

Under the guise of reducing the cost of living, the Federal Government has abolished the carbon tax, wound back the Renewable Energy Target by a fifth and frozen energy efficiency standards. The promised emergence of Australia as a low-cost energy superpower if we just slashed climate change regulations has clearly failed to materialise.

In fact things have become far worse.

Prices for power on the forward electricity contract market are now trading at levels double what the wholesale market price was when the carbon tax was in place. They are now some of the highest in industrialised world.

Power contract prices for next year now far higher than wholesale spot prices during carbon price period

Source: AEMO, ASX Energy (at March 29)

Some in the media and politics have suggested renewable energy is to blame for this situation. This reflects a complete ignorance of the historical context of key factors driving Australia’s east coast electricity market.

During the 1970s and ’80s state governments went on a coal-power-station construction binge to meet power demand that never materialised. While these plant are expensive to build they are cheap to operate and the large oversupply of coal plant kept our power prices low.

In addition we had a Goldilocks set of conditions for gas supplies. They were too small in size to build export infrastructure but more than enough for domestic demand. This gave east coast Australia some of the lowest gas prices in the world.

Now these coal power plants are becoming old and several require significant investment to continue operating safely, reliably and efficiently.

Conscious that these plants are incompatible for emission-reduction goals, investors are electing to shut some of them down rather than sink good money after bad. This is well illustrated in what was uncovered in a freedom of information request of Victorian Worksafe inspection results of the Hazelwood Power Station. These inspections found an array of safety problems associated with a plant that had become very old and was wearing out. According to an ABC news report the owner of the plant, Engie, responded it would have cost $400 million to revamp the plant to address these safety issues – which was not economically viable.

At the same time discoveries of large amounts of gas in Queensland coal seams has supported the construction of liquefaction plants that can export our gas to high-paying Asian customers. These plants, enthusiastically supported by both Labor and Liberal-National governments, have tripled east-coast gas demand in the space of just three years.

The Australian Industry Group’s recently published survey of Australian business CEOs documents just how dramatically contract prices for wholesale gas have escalated since 2015 (when Queensland’s LNG plants exported their first shipment of gas). These prices are well above those prevailing internationally across the US, Europe and even the Asian countries that we are exporting to.

Australian Industry Group survey results indicate rapidly rising gas contract prices

Source: Australian Industry Group (2017)

With the closure of Hazelwood power station and potentially other coal plants in a few years’ time, our east coast power prices are now increasingly set by very expensive gas generators. While plenty of coal plants remain that are cheap to operate, they will simply take big windfall profits rather than push prices down.

Chart three, prepared by the Australian Energy Market Operator (AEMO), details an already stark increase in the amount of time gas generators set the wholesale market price (shown by the yellow dots) in 2015-16 compared to 2014-15 and the large lift in prices that accompanied this.

Wholesale power price duration and associated price setter by fuel type in 2014-15 versus 2015-16

Note: Yellow dots indicate points where gas set the spot market clearing price, orange denotes Brown Coal, grey denotes black coal, and blue denotes hydro. Source: AEMO

In its March Gas Statement of Opportunities for Eastern and South-Eastern Australia AEMO observed: “As coal-fired generation in the NEM withdraws, and reliance on GPG [gas power generation] increases, electricity spot prices are becoming increasingly linked to gas spot prices … Not only are the prices across 2015–16 higher than those in the previous year, the fuel setting the price most often is natural gas for GPG.”

To reduce the extent to which now very expensive gas generators set power prices we need to make urgent and substantial investments in both energy efficiency and renewable energy plant.

As shown in chart four, based on a survey of international renewable energy procurement auctions, the price of power from solar and wind is about US$50/MWh, or roughly $67 in Australian dollars. This is well below prices being seen in the NEM wholesale electricity market.

Average prices resulting from international renewable energy auctions 2010-2016

Source: International Renewable Energy Agency (2017) Renewable Energy Auctions – Analysing 2016

The recent surge in investment in renewable energy plant driven by the 2020 Renewable Energy Target should help as these plants are constructed. But because of fears of oversupplying a scheme due to its fixed 2020 target, investment is likely to fall away within two or so years. In addition, Australia’s energy efficiency standards program has been stalled by a ridiculous requirement that one regulation must be scrapped before another can move forward. This leaves us in a no man’s land with little investment in either more supply or improved energy efficiency.

In terms of driving new investment in renewable energy the Victorian and ACT government’s awarding of long-term contracts to new renewable energy plant will certainly fulfil the brief. In addition we also expect an emissions intensity trading scheme would do the job provided its objective was consistent with Australia achieving its 2030 emission reduction target and didn’t allow for loopholes such as the use of cheap international credits. Yet the federal government has ruled out both of these options. Meanwhile, state-based schemes are threatened with abolition by state Liberal-National opposition parties.

Our paper puts forward an alternative option that seeks to capture advantages from across the range of policy options for decarbonising Australia’s electricity supplies.

It would involve taking the existing Renewable Energy Target structure of power retailer target obligation as the mechanism for paying for the scheme. But it addresses critics’ concerns by also allowing fossil fuel plant to qualify where emissions intensity is low enough to assist in achieving the 2030 emissions target.

In Prime Minister Malcolm Turnbull’s words it is “technology agnostic”.

It then borrows from the former Abbott government’s Emission Reduction Fund model of reverse auctions that award long-term abatement contracts to the lowest bidders (we suggest a 15-year contract term).

The provision of long-term contracts with government acts to mitigate investor concerns about regulatory change which have beset both the Renewable Energy Target and prior carbon pricing initiatives. This is because the contract with government should be able to be enforced by court action just like any other contract.

Such a scheme represents a significant advance on an emissions intensity trading scheme for electricity consumers because it should avoid handing windfall gains to low-emission plant like hydro generators that were built decades ago. At the same time it delivers greater revenue certainty to investors by virtue of government offtake agreements for the carbon abatement.

The federal government faces a simple choice. It can continue to reject policies that will put legislative power behind its Paris targets and power prices will remain extremely high. Or it will take on the climate science ignoramuses in its party and introduce a policy to stimulate investment in renewable energy and bring down power prices.