18 minute read
Dr Kerry Schott AO | Chair, Energy Security Board
Key points:
• High consumer prices, uncertain emissions reduction policies and energy reliability are now major issues. • Political overreaction in the energy sector is unable to deliver sound policy outcomes. • There is no single measure to ‘fix’ the electricity market; it will rely on a suite of responses.
I have recently been appointed as Chair of the Energy Security Board (ESB). Being someone who enjoys a challenge, I accepted the role.
The key task of the ESB is to implement the recommendations in the Final Report of the Independent Review into the Future Security of the National Electricity Market (the Finkel Report), which is a blueprint for how to reform the electricity market.
The other members of the ESB are: ► Clare Savage (Deputy Chair) ► Paula Conboy ► John Pierce ► Audrey Zibelman.
The National Electricity Market (NEM) has existed for about 20 years. It is a wholesale market for electricity across Queensland, New South Wales, the Australian Capital Territory, Victoria, South Australia and Tasmania. It does not include the Northern Territory or Western Australia.
The interconnectors across the state boundaries are quite thin. Recently, the New South Wales Minister for Energy remarked that the ‘market is hardly national’. This is a valid statement, given that the grid is constrained by power connections across state borders.
Within the NEM, generators provide electricity and bid at five-minute intervals across the day. The Australian Energy Market Operator (AEMO) then ranks the bids from cheapest to most expensive in order to meet the demand required by the market. The NEM then dispatches energy, and AEMO’s role is to ensure that the system remains stable as energy is
dispatched. The price received by generators for the energy being dispatched is the highest price accepted by AEMO as part of the bidding process – prior to distribution.
For example, when bidding, AEMO knows how much needs to be supplied over any interval of time, and it takes the cheapest bidders until the requirements for those time intervals have been met. Generally, the most expensive bidders are gas and coal generators. The system we have has traditionally worked well; however, this is increasingly no longer the case.
The NEM is an energy-only market, meaning that it is based entirely on the price of energy. When electricity is scarce, the price increases significantly. When the NEM reaches capacity and there is a shortage of supply, the high prices are sustained for long periods of time. This approach is supposed to encourage new plant, repairs, maintenance and upgrades.
To protect market participants against price volatility, there is a cap, meaning that the price of electricity cannot rise above a particular threshold. There is also a price floor, which is, in effect, set by the lowest bidder in the market.
How the NEM has evolved over the years is quite interesting. The system has always had excess capacity and has worked efficiently as a result. When there is excess capacity, there used to be a competitive bidding process by the generators, which kept electricity prices quite low. Until recently, consumers enjoyed good outcomes, and there was no need for additional capacity in the markets, except for gas peaking plants, which provide power at the peak periods of the day.
Network businesses, such as Ausgrid and TransGrid, are all regulated by the Australian Energy Regulator (AER). Network businesses are in the market to transport electricity in a highly regulated environment. Whilst they have contributed to the higher prices consumers pay, they are not a major driver behind the current market volatility.
There are three major contributors to current market volatility: ► high consumer prices ► uncertain emissions reduction policies ► future levels of reliability and security being called into question.
The ESB is extremely concerned about this summer. AEMO has already put out a warning to Victoria and South Australia to ensure that they have enough power for the summer months. Similarly, New South Wales will have reliability issues when the Liddell Power Station closes in 2022.
Australia has several management issues to deal with. The first is the increasing proportion of wind and solar power in the market, alongside the retirement of older coal and gaspowered generators. For example, the Hazelwood Power Station shut rather unexpectedly, catching everyone by surprise. Similarly, more coal and gas power plants will retire over the next 20–25 years.
Past lessons have taught us that as change occurs in the electricity market, politicians become very concerned about the ‘lights going out’, and can overreact. Public servants still tell the story of then New South Wales Premier Neville Wran demanding that more power plants be built while he was in London during a series of rolling blackouts in New South Wales. That is how Mount Piper, Eraring, and Bayswater, which are the big power plants in New South Wales, came into existence. These plants added to the overcapacity in the market, largely in New South Wales and Queensland.
One of the issues that we are facing is the risk that we will have another overreaction, which is why the Finkel Report is important. It provides us with a blueprint for a very orderly energy transition to get from where we are now to where we need to be.
On the price front, what happens with wind and solar is interesting. When the wind is blowing or the sun is shining, renewable generators bid their price into the market at a marginal cost, close to zero. As the level of renewables increases and is bid into the market, this is first accepted for dispatch, as it is bid in at a comparatively lower price to traditional generation. The market still requires coal and gas-fired plants to provide system inertia and be available when the sun does not shine, or when the wind stops blowing.
As noted earlier, we have a situation whereby a fleet of renewables is coming into the market at the same time as a fleet of coal and gas-fired plants is retiring; however, we still require a portion of that fleet to keep the system stable. The converse impact on prices is that they bounce around from being very low when all the renewables are running, to extremely high when the renewables are not running. This occurs when coal and gas generators are bidding into the market and trying to make enough money to cover all the intervals in which they have not
been able to dispatch energy. This leads to enormous volatility in prices, which we are seeing in South Australia at the moment.
The price of coal has also risen – it used to be about $25 a tonne, and it is now around $50–60 a tonne. Gas is also very expensive, with costs determined by fuel prices, which have all gone up. This has added to the volatility in the market, and has created a challenging environment. One of Dr Finkel’s primary concerns is reliability. In effect, the questions we need to be asking are: have we got enough supply to meet demand? Have we got it all the time? Have we got it when the wind’s not blowing and the sun is not shining?
The question that follows then is: will the market, as it is currently set up, provide the necessary signals to encourage market participants – the private sector – to invest in new plant? At the moment, this is not happening due to a number of reasons. Even if we had a Clean Energy Target, the jury is still out on whether an energy-only market would provide the right signals. In other offshore jurisdictions, when there is a large increase in the proportion of renewables in the system, an environmental target and an energy price market, a capacity charge tends to be introduced. A capacity charge means gas and coal plants are paid for being available, as well as for what they bid into the market. A capacity charge changes the market system, making it very complicated. No-one, including Dr Finkel, was prepared to go down that path. It may be the right
Source: TransGrid answer, but there is a lot of ongoing work about whether or not we need to introduce one.
The other necessity is system security, which means keeping the grid stable. For system security, you need steady frequency and a steady flow of power. That is something that the laws of physics dictate, so as we increase the proportion of renewables, we need to make sure that we have responses in case of sudden outages, such as during a severe storm or fire, or a major plant going down.
Australia is a country that is prone to outages caused by extreme weather events. What happened in South Australia was unusual in its severity, but not unusual in the fact that it happened. All of these issues are adding to the need for storage – either in batteries or hydro – for fast frequency responses, and also in new technical specifications for renewables.
AEMO is also looking at whether we should have a reserve market in the future. One of Dr Finkel’s suggestions was to look at the possibility of having a short-term response, which is a reserve that is auctioned and provided by gas and coal plants. AEMO recently proposed this idea, and is now looking at how to set up a reserve market auction. This reserve would only be used in extreme cases, such as in the case of a storm or 40-degree days in Victoria, South Australia and New South Wales, for example.
Another vital area of consideration is the high prices we are currently experiencing. For retail customers, the information they receive on their bill is complicated and opaque. The Australian Energy Market Commission (AEMC) has made numerous recommendations about making household bills clearer and more competitive, and the Prime Minister has been correct to berate energy retailers.
The major retailers spend most of their marketing budget on retaining their customers, not on explaining their tariffs, or encouraging different types of offers. Currently, with the type of offer you are on, it is not clear: ► if you have got a discount ► how long it is for ► how long it will be available for ► if you are subject to a late payment charge ► if there is an exit fee if you switch providers ► if there is a payment processing fee, with or without a credit card, or both.
There is a government website, ‘Energy Made Easy’, that is designed to help people to work out what is in their bill; however, if you go onto that website, you will find that it is clunky and anything but easy. One of the recommendations in the Finkel Report is that the AER should fix this website. It is unlikely that we will have a good website for people to select and shop around for energy offers until the information is made available to the private sector to develop applications that will
get information promptly to consumers.
The other thing that could help with bills is if people use less power. It really does strike me, coming from the water industry, how little focus there has been in electricity on demand response. It is starting to happen, and it has always happened with big customers that write contracts where they are rewarded for cutting back at particular times. On 10 February this year, New South Wales had a big scare, and Tomago had to cut back on the power that they were using for the aluminium smelter – they would have received a handsome sum of money for cutting back when they did.
Not all companies can do that, but with all of the solar PV that exists in the market, we are now at a stage where there is technology that can join panels together in ‘mini communities’. This allows the panels to share power between them, and introduces innovative technology to control things, such as pool pumps, and allows for your hot water system to be turned on at 3:00 pm instead of 4:30 pm. All of these measures will save enormous amounts of power. In America, the amount of power that’s saved through these sorts of demand-response mechanisms is at least two times the size of Liddell.
We can expect huge advances in the distributed energy resource world – there are incentives being designed by some of the market players in order to do this at the moment. The amount of small-scale solar at the start of the last decade was about 100 megawatts – it’s now up to 4,600 megawatts, which is the size of a large power station. AEMO predicts that this will be 20,000 megawatts by the late 2030s.
It is also becoming increasingly difficult to hedge against price risk. The big users have always done this both bilaterally with the supplier and through financial contracts in the market. With the current price volatility, it is difficult to obtain market information – market gossip suggests that it is quite illiquid. That’s been making it quite hard for both generators and large customers to protect themselves against price volatility. When prices are unable to be hedged, the likelihood of higher spot prices and ceiling caps increases. This does not help to moderate volatile price behaviour.
Dr Finkel made 50 recommendations in his report, and in an unprecedented level of agreement, the COAG Energy Council accepted 49. The one recommendation not agreed upon was the Clean Energy Target – work on that is still ongoing. I would not give up on it. When you look at the Finkel Report, there is a lot of information – a lot of relatively small technical measures grouped in with big policy changes. These can be addressed under four headings: ► reliability ► security ► lower emissions ► consumer rewards.
Reliability is about demand exceeding supply. The main solution to this problem, according to Dr Finkel, is to set a Clean Energy Target, because once industry has certainty, they will invest in more plant, and there will be more supply. There are industry stakeholders with gas-fired plants that are almost ready to go, but they are uncertain about the future, which means that investment is delayed.
Source: TransGrid
Another thing the Finkel Report suggests is a generator reliability obligation for all new generators – largely renewables. If you construct a wind farm in South Australia, you will also be required to provide backup dispatchable power so that supply increases at all times due to the new generator. If you are a generator looking to close down, it is suggested that you provide three years notice of closure. The sudden closure of Hazelwood last April took the market by surprise. When a big plant like that closes its doors, the market needs more time to be able to respond. The other recommendation with regard to supply is the formation of a strategic reserve, which AEMO is already acting on.
Security relates to obligations on new generators to make sure that they have fast frequency responses to cover outages in the system. Transmission companies have an energy security obligation, and across the grid they have to make sure that there is enough inertia to keep everything moving. Stronger risk management is also required around cyber threats, but also against natural disasters. The way that transmission towers collapsed in South Australia during the storm makes you wonder whether the engineering specifi cations might need to be reviewed. All of these elements need to be considered.
In terms of lower emissions, we need a Clean Energy Target. We also need to set a future emissions reduction path that is technology-neutral. The way the Clean Energy Target works is to set a threshold, so that if a plant is operating below the target, it receives certifi cates that can be traded. If a plant is operating right on target, then it does not need to purchase any certifi cates, as it’s a neutral player. If it is operating above the target – for example, a coal-fi red power station – then it will require certifi cates from elsewhere, which will make the operating costs more expensive.
We also need more capacity in the system. This means that we need investment. There is a lot to be gained through the demand-response mechanisms, and also in providing more transparency and consumer choice to allow the public to make informed decisions.
In conclusion, there is no one single measure that is going to fi x the market. What is required is a mix of demand response, increased dispatchable capacity, better consumer choice and competition, and ongoing reductions in emissions to reach ‘nirvana’ – affordable, reliable, secure, low-emissions power supply.
Dr Kerry Schott AO – Chair, Energy Security Board
Dr Kerry Schott is Chair of Moorebank Intermodal Company, is a Director of NBN, and a Director of the New South Wales Treasury Corporation. Dr Schott also chairs the Assurance Board for Sydney Metro, and is a member of the Advisory Board for City and South East Light Rail.
Dr Schott was Managing Director and CEO of Sydney Water from 2006 to 2011. Before that, she spent 15 years as an investment banker, including as Managing Director of Deutsche Bank and Executive Vice President of Bankers Trust Australia. During this time, she specialised in privatisation, restructuring and infrastructure provision. Prior to becoming an investment banker, Schott was a public servant and an academic.
Dr Schott holds a doctorate degree from Oxford University; a Masters of Arts from the University of British Columbia, Vancouver; and a Bachelor of Arts (fi rst class Honours) from the University of New England. She was recently awarded an Order of Australia and Honorary Doctorates from the University of Sydney and the University of Western Sydney.
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