Issue 95, March 2013
Welcome to the third issue for the year, writes Keith Orchison. High on the list of current concerns for the energy industry are the ongoing issues with red and green tape and the inability of governments to leave supply to an efficiently-regulated marketplace.
The energy industry has reacted with ire to the sudden move by the New South Wales government to declare “no go” zones for coal seam gas exploitation – and the response is the tip of an iceberg of frustration across the sector about political ineptitude nationally in overseeing exploration, development and power production.
The federal government has recognised part of the problem by requiring the Productivity Commission to evaluate non-financial barriers to exploration – and the commission is looking for submissions by this month on the issues paper it published in December. Its final report is due next September.
While the commission is highly respected in corporate Australia and the report will be welcomed, companies have more immediate causes for concern.
A particular focus in March is the O’Farrell government’s sudden decision, without further consultation, to ban all coal seam methane activities within two kilometres of residential areas across NSW, having previously introduced a “strategic regional land use policy” allowing this after 15 months of thinking about the issue.
The government’s approach is notionally open for discussion with industry, but it is hard to see how it can backtrack without political damage.
Energy Policy Institute of Australia executive director Robert Pritchard decries it as “a decision made behind closed doors with no transparency and no consultation,” arguing that energy policymaking requires an open, transparent and trusted process where key stakeholders are provided with adequate information and have an opportunity to present their views.
Under the new rules the Environmental Protection Agency will be chief regulator of the coal seam gas industry and the State’s chief scientist has been directed to conduct a review of all CSG activities in NSW to identify environmental risks.
The latest developments in NSW need to be seen against the federal government releasing a draft harmonised regulatory framework for CSG last December, but the States continue to go their own way, with Victoria imposing a moratorium on hydraulic fracturing by the gas industry just as NSW was lifting its moratorium on fracking.
Lawyers K&L Gates warn that governments are risking turning off overseas investors by pursuing conflicting and half-baked regulations just at a time when international interest in Australian unconventional gas resources has been gaining momentum. “When you’ve got different regimes with different emphases and sometimes inconsistent objectives then that causes uncertainty,” says the firm’s Clive Cacchia.
“The goalposts keep moving in NSW,” the Australian Petroleum Production & Exploration Association complains. “Now there is more red tape and green tape to go through. The latest decision appears to be arbitrary and sends a clear signal that NSW is closed for business.”
The association adds that a more logical approach, if the State government wants to protect the values of certain area, would be to specify the outcomes required so that petroleum businesses can they can achieve them.
It points to Queensland where “gas is being safely and effectively produced from 3,524 wells.”
The most affected company, AGL Energy, says the move “adds to the supply crisis NSW is facing as existing supply contracts roll off between 2014 and 2016.”
AGL has been producing CSG from wells in the Camden area of outer Sydney for a decade and the company points to extensive surveys demonstrating that its wells do not interfere with the water table.
APPEA adds that there is no evidence of ground subsidence related to the Camden gas operations, decrying “baseless alarmism” on the issue shortly before the O’Farrell government decision.
With suggestions that CSG production worth as much as $4 billion may be sequestered by the new restrictions, both APPEA and the Energy Supply Association are warning that the result will be higher energy prices.
ESAA claims that the cumulative effect of the new steps in NSW could be an extra $2 billion in costs for consumers over the rest of the decade on top on revenue lost to taxpayers through lower taxes.
“There are significant gas pricing pressures building in NSW,” says ESAA’s Matthew Warren. “The only way to alleviate them is to produce more gas. Households want relief from rising energy bills and the State desperately needs new investments to unlock growth.
“The decision to block CSG development does everything to make the situation worse.”
Needless to say, having seen the O’Farrell cabinet’s knee jerk under sustained political and media pressure, neither farmers opposing CSG activity nor the environmental movement are satisfied and are already calling for further restrictions.
Although the likely outcome of the latest Queensland Competition Authority review of power bills for regulated household and small business was obvious to informed observers, the leaders of the State government, Premier Campbell Newman and Treasurer Tim Nicholls, declare themselves “shocked” by the draft decision and have been in engaged in lifeboat drill since the announcement in mid-February.
The QCA, which deliver its final decision in May, proposes average household bill increases of 21 per cent, with small businesses facing 15.7 per cent rises.
The regulator explains the outcome like this: “Electricity prices in Queensland are under acute pressure from rising network costs and the rapidly growing cost of solar feed-in tariffs.
“Network costs in south-east Queensland are forecast to rise by 23 per cent in 2013-14. Embedded in these charges is the cost of ‘solar bonus’ subsidies for households with solar panels (which have encouraged use of rooftop arrays to rise by almost 200,000 in four years).
“Higher network charges, including the network costs deferred in 2012-13 (by the Newman government to honor an election promise) account for 72 per cent of the increase for a typical residential customer.
“The determination also forecasts increases in the cost of electricity generation, retail costs, the carbon tax and the renewable energy target.”
The ruling, when confirmed, will add an extra $253 a year to average household power bills – or 69 cents per day.
Why any of this should shock government leaders is difficult to say, but the Newman government has been quick to declare that it finds the increases “unacceptably high” and is looking at another taxpayer subsidy – the current freeze has cost taxpayers about $60 million – or making the government-owned network companies absorb some of the cost.
The political target apparently is to reduce the increase to a “single-digit” number.
Treasurer Nicholls says that the government has already driven the networks to cut $2 billion from capex and opex outlays approved by the Australian Energy Regulator for expenditure over three years.
While the Newman government seeks to conjure up a get-out-of-jail card, the Energy Supply Association argues that price regulation is “failing Queensland families.”
ESAA’s Matthew Warren says last year’s price freeze decision only delayed higher costs. “Freezing electricity prices doesn’t work as eventually they have to catch up with the real cost of generation and distribution.
“The only way to make electricity more affordable for Queensland families is to encourage more competition in the retail market so that energy companies have to cut their prices to get customers’ business.”
Warren adds that last month’s move to deregulate the South Australian market has led to customers immediately being offered discounts on their bills of up to 16 per cent.
Prices in Victoria, the first State to deregulate, are 20 per cent cheaper than in Brisbane, he says.
“Regulation strangles competition. It means governments get blamed for price increases they can’t control and takes away choice from consumers. Once energy retailers know government won’t interfere in the market, they cut their margins and put up discounts to get and retain customers.”
His views are supported by Cameron O’Reilly, executive director of the Energy Retailers Association, who says that a competitive and deregulated market, as in Victoria, is the best way to ensure lower prices.
A commission of audit, chaired by former federal Treasurer Peter Costello, has told the Queensland government that failure to bite the bullet on energy asset privatisation recommended by its predecessor in 1996 has cost taxpayers $7.2 billion (in current dollar values).
Now the Costello commission is telling the Newman government that today’s energy assets are sufficiently attractive to the private sector that they can be expected on their own to deliver the $25 billion debt reduction needed to recover the State’s triple-A credit rating.
At present the government owns two generators, CS Energy and Stanwell Corporation, and three network businesses, distributors Energex and Ergon Energy and transmission company Powerlink. Most of the sale value (about $17 billion) is seen as lying in the network businesses.
The commission’s final report – of which only the executive summary has been released so far – uses language about power privatisation that will also resonate south of the Tweed River where the O’Farrell government has been vacillating about how far it should go.
The NSW government is engaged at present in seeking to sell all of Macquarie Generation and those assets of the other two generation businesses, Eraring Energy and Delta Electricity, that were not sold by the Keneally ALP government in 2010 in controversial “gen-trader” deals.
It says, however, that it does not have a mandate in its present term to sell its three distribution businesses now grouped under NSW Networks and transmission company TransGrid.
In the present environment, it is possible that as much as $60 billion worth of east coast electricity assets could be up for sale after State elections in 2015, creating global investment interest, especially in the “wires” businesses.
The Costello commission of audit paints a stark picture for Queenslanders of the challenges they and their governments face over the next 25-40 years.
The State’s economy has been driven over the past 25 years, the commission says, largely by population growth, increased workforce participation and the development of vast mineral resources – and it cannot rely on these factors alone for the next 25 years and beyond.
Modelling undertaken for the commission, it says, suggests that the State’s long-term economic growth per capita over the next 40 years is likely to be significantly lower than has occurred over the past quarter century.
“If the government does not engage in long-term planning in an ordered and coherent way,” it adds in a message that applies to all Australian jurisdictions, “it will be forced by crisis to respond to emerging pressures in an ad hoc and sub-optimal manner.”
The commission also notes that “there is constant pressure on State governments to improve services and to take on new responsibilities.”
It says: “If (the Queensland) government wants to deepen and widen its engagement in some area, it will need to pull back in, or withdraw from, others unless the community is prepared to pay ever-higher levels of taxation.”
It points out that the challenge for any government is to establish an environment where services are provided efficiently, at lowest cost and at least financial risk to the State.
The commission asserts that the government-owned electricity assets in Queensland are not managed as efficiently as they could be under private ownership “and it is unlikely they ever could be in government ownership.”
Full privatisation is not the only option, it tells the Newman government.
“Significant capital to pay down (State) debt could still be derived from these businesses through long-term leases, securitisation of income streams, joint ventures, partial sales and contracting out of various operations.”
Given the competitive wholesale market on the east coast and the federal regulation of networks, the commission says, ownership of the assets does not determine the cost of supply. “In particular, whether these assets are owned by government or the private sector, is not the determinant of the electricity charges consumers pay.”
The Queensland government says it will reveal its response to the report – and the full 1,000-page document – in about two months.
The Australian Competition & Consumer Commission has again signalled that it is keeping a close eye on the NSW generation privatisation process.
Speaking at a Committee for the Economic Development of Australia forum on its agenda for 2013, ACCC chairman Rod Sims said he “expected that the commission’s attention will be drawn” to privatisation of generation assets, which are under way in NSW and mooted for Queensland.
“We need to ensure,” Sims said, “that the market structure around the NEM continues to encourage vigorous competition.
“With privatisation, the NSW and Queensland governments have a one-off opportunity to influence the long-term structure, and hence the level of competition, of the NEM.
“Get it wrong and the industry will suffer from the exercise of market power for many years to come, ultimately to the detriment of consumers.
“Get it right and strong competition will drive prices to efficient levels.”
Sims told CEDA that, until recently, electricity reforms had tended to focus on the wholesale market and the establishment of a national grid network, but now a major emphasis is also to ensure that the market delivers for consumers.
He said that creating a Consumer Challenge Panel as a “critical friend” for the Australian Energy Regulator has “the potential to add a fresh perspective and additional rigor to regulatory decisionmaking.”
He also welcomed the move to establish a national consumer advocacy body to provide a customer voice for energy policy and regulatory development.
“I have argued for the establishment of a well-resourced national energy consumer advocacy body for some time,” Sims said. “One with the capacity to participate in these complex debates is needed to balance (them) on many fronts.”
While the direction of power bills in the short term is obvious, a continuing climb over the rest of the decade is open to question at least.
AGL Energy economists Paul Simshauser and Tim Nelson have contributed a chapter to the 2013 “Economics and Political Outlook” published by the Committee for the Economic Development of Australia in which they trace the path of household charges from the middle of the past century until now and then look forward.
They point out that pricing history has been dominated by two sustained periods of real (i.e. inflation-adjusted) reductions – first between 1955 and 1979 and then between 1985 and 2008.
Since 2008-09 electricity network augmentation and the need to replace aged assets have been the major factors in driving big increases – with significant political fall-out.
Simshauser and Nelson argue that one of the key components of the current situation has been the failure of genuine demand-side reform. “Time-of-use pricing is virtually non-existent at the residential level with the exception of electric hot water loads.”
The critical question for policymakers today, they say, is how best to repeat the “harvest period” of 1985 to 2008 now substantial infrastructure investments have been sunk? “The short answer is to focus on demand-side reform."
They call for policymakers to concentrate on pricing structures and other incentives to reduce critical peak demand, not on changing underlying energy demand, warning that allowing peak consumption to continue to rise when energy demand is being suppressed will result in poorer capacity utilisation, increasing costs and price rises.
Four universities have been given $3.3 million by the CSIRO Future Grid Flagship to investigate the most economically efficient power network for Australia’s future.
The grant will be shared by the University of Queensland economics school, the University of NSW centre for energy and environmental markets and researchers from the universities of Sydney and Newcastle.
UQ’s professor John Foster says an important part of the research will be to explore the economic impact of investments in solar, wind and geothermal energy on the east coast NEM. “A key focus will be the forecasting of price levels and volatility of the market” under a substantial shift towards renewable sources.
The overall outcome of the research is intended to identify low-cost methods for integrating large and small renewable energy sources in to the NEM grid as part of the effort to lower Australia’s carbon emissions.
Meanwhile, UQ’s Global Change Institute has published another report in a series examining the characteristics of a competitive electricity system and what the NEM may look like in a couple of decades under existing policy and institutional settings.
The second in a trio of papers – the first was published last year and the final one is scheduled to appear later in 2013 – asserts that the NEM as presently set up is not able to deliver the electricity industry’s share of the targeted 80 per cent national emissions cut by mid-century.
It claims that the resilience of Australia’s power economy is currently poor by international standards (compared with resource-rich competitors) – saying it is only better than India and South Africa without their low electricity prices.
It argues that resilience in the power system has declined over the past 20 years and that one of the outcomes is that Australia’s share of electricity-intensive metals processing has also fallen back.
The UQ paper highlights the enormity of the carbon policy demand on the electricity industry. The GCI researchers say that reaching the 2050 target will require the power sector’s share to fall from 183 million tonnes carbon dioxide equivalent to 167 Mt in 2035 and just 32 Mt in mid-century.
The institute says industry and government face two basic choices: start now on a course of action that will lead to the targeted abatement, reduce pressure on power prices and offer increased technology choice by 2025 – or wait until new technologies options become available and “implement them in relative haste.”
GCI researcher Lynette Molyneaux says the challenges facing the power industry are “significant” with a large proportion of current infrastructure needing to be replaced. “Meanwhile the industry is under the gun for escalating prices."
Molyneaux says that, if the dominant industry view is accepted, with gas turbines replacing coal-fired generation, “the power system in 2035 will be only marginally more resilient.”
She adds: “Replacing coal with gas will not set Australia on a path to reducing emissions 80 per cent by 2050” and notes that there is a gap in understanding the extent of investment needed in power networks to deliver a major shift in supply to renewables and distributed generation.
Assuming that the Liberal and National parties emerge victorious from the 9 March election in Western Australia, which is the prediction of all the main opinion polls, the State government will be on a path to backsliding on one of its most important economic efforts over the past four years.
The Coalition government led by Colin Barnett was confronted in 2008, when it narrowly defeated the long-serving ALP regime, by an electricity industry in disarray because Labor had not increased power prices for a decade.
For 10 years between 1997 and 2007 successive Labor governments held to a policy of keeping residential tariffs unchanged. As a result, just through inflation, bills fell 47 per cent.
One of the critical side-effects of this policy was a substantial under-investment in networks over a decade while household demand has risen to more than 6,000 kilowatt hours a year.
With the ensuing debt, loaded on to the government-owned generation business, threatening to reach $3 billion by mid-decade, the Barnett government instituted a series of substantial electricity price increases – bills rose by 57 per cent in three years.
The outcome is that the average household electricity charge in the State’s south-west has risen from $963 in 2009 to $1,515 at present – still well below what households are paying in most of eastern Australia despite WA having a large uptake of air conditioning to cope with the weather.
Even so, according to the State regulator, in 2012-13 there remains a 12 per cent gap between the average tariff for householders and an efficient cost-reflective price.
The regulatory proposal was that imposing a 6.7 per year increase in tariffs would get bills in the West to cost parity by 2015-16. (The estimated CPI rise for this period is 2.5 per cent a year.)
However, with an election imminent, and the local media loudly decrying price rises, with opinion polls reflecting householder unhappiness, Barnett first blinked in the last WA budget, reducing the next tranche of increases to just five per cent.
In the election campaign, confronted by Labor’s leader, Mark McGowan, in the sole televised leadership debate, with the accusation that the budget papers showed prices would rise 25 per cent higher, Barnett cut and ran – he committed a new Coalition government to restricting price rises over the next three years to the rate of inflation, a guarantee that they will make no further progress towards being cost-reflective.
Even increasing prices 62 per cent over four years has left the State government subsidising power bills to the tune of $371 million in 2012-13.
Its budget planning intention, which Premier Barnett has now junked, was to limit the subsidies with further increases of 10 per cent in each of 2013-14 and 2014-15.
What’s more, holding down the level of subsidies depends on the State-owned energy retailer, Synergy, achieving substantial efficiencies; otherwise, on the estimates of the regulator, there will be as much as another $95 million a year to be funded.
Before Barnett’s knee jerked, the government had budgetted to spend $595 million in subsidising electricity supply below cost to households over the next four years. Under his campaign commitment, this must rise – although his government also benefits from a surrogate tax in the form of more than $80 million a year in dividends delivered by the State-owned network business, Western Power.
In addition, the State government is committed to an energy subsidy for needy households that is budgetted at an aggregate $286 million between 2012-13 and 2015-16.
As well, Synergy picks up part of the tab for the solar feed-in tariff scheme – estimated to cost it $61 million between 2012-13 and 2015-16.
The infrastructure outlay to sustain the reliability of the WA south-west electricity grid and its mining areas is $1.4 billion in 2012-13 and is expected to lie at similar levels over the next four years with the State’s population increasing at a faster rate than the national level.
The budget papers expect investment by Western Power to be $4 billion over four years, including $1.2 billion on upgrading the network to improve safety, of which $863 million will be spent on replacing wooden poles.
Network costs make up 40 per cent of the final bill for residential customers in the south-west.
There is a telling sentence in a commentary by chairman John Pierce in the Australian Energy Market Commission’s latest annual report, tabled late in February.
“One of the things (of which) we are very conscious at the moment,” says Pierce,” is the uncertainty surrounding the future shape of the energy sector – a direct result of technological change and increasing linkages between the Australian domestic energy market.”
What it would be impolitic for Pierce to add is that the activities of most politicians, regardless of their party, are also not helping to relieve this uncertainty.
Certainly, the longest-drawn-out federal election campaign in Australia’s history is not designed to see investors feeling any happier about spending funds here.
At the same time that Pierce’s report was being published, David Knox, who is both chief executive of Santos and chairman of the Australian Petroleum Production & Exploration Association, was calling for “a very steady hand on the policy tiller” through the election period and beyond.
Like many corporate heads, Knox is seeking to straddle a barbed wire fence – for example he seeks support from both Labor and the Coalition to continue withstanding manufacturers’ pressure for a gas reservation policy in eastern Australia and he also favours retention of the carbon price policy.
Knox told the “Australian Financial Review” that he didn’t want to see any major changes in policy directions over the next 12 months. “We don’t want anything that wobbles confidence.”
Uppermost in his mind, perhaps, was the just-announced volte-face by the O’Farrell government in NSW over access to coal seam gas resources.
His opposite number at Origin Energy, Grant King, was on the same page: “How many policies are we going to see coming out of government and opposition (during the election campaign) that are not necessarily as soundly economically based as you’d like?” he said.
APPEA called last month for energy security to be “above politicking,” lamenting the “current round of baseless and politically-motivated alarmism undermining the capacity of the industry to deliver new gas supplies to the people of NSW.”
Professor Stephen Martin, a former federal Labor minister and ex-Speaker of the House of Representatives, now chief executive of the Committee for the Economic Development of Australia, launched CEDA’s 2013 economic and political overview in mid-February and called on the major political parties to “outline their long-term vision, not just for the next election cycle.”
Nothing is perhaps more central to the hopes and fears of these leading stakeholders than how politicians tackle the unnecessary regulatory burdens that have been imposed on the energy and resources sector across Australia in the past five years – and at present the subject of a Productivity Commission review, which will only be published towards the end of this year.
In the issues paper it issued last December, the commission draws attention to the increasing coverage and complexity of the permit and approvals system in this country as a result of “incremental responses to various demands rather than as part of an overall plan.”
It also focusses on inefficiencies due to overlap and duplication between different regulatory schemes, such as those imposed by the federal government and the States for environmental impact assessments.
The federal government specifically excluded taxation and fiscal policy from the commission’s scrutiny in this review – it would, wouldn’t it? – and it can run all it likes but it can’t hide from the impact of these factors on energy planning and investment across the board.
It is worth noting here, as the Productivity Commission does in its issues paper, that the global standard for the attractiveness of jurisdictions for resources investment is the annual study undertaken by Canada’s Fraser Institute.
In the institute’s 2012 report card, out of a potential score of 100, Western Australia and the Northern Territory each achieved 81.5, South Australia 75.3, Queensland 65.5, Tasmania 64.8, NSW 62.4 and Victoria 52.1
As a submission to the commission from a contract geologist says, “The problem with governments at all levels is their inability to be trustworthy.” He laments that governments today are “ruled by the vocal minority, the media and vested interest parties, who do not know or do not want to know that they have created a long-term problem.”
Contrast this with what Pierce says in the new AEMC report about the environment for electricity use:
“Over the past 15 years, the size of our homes, our use of air-conditioning and the big increase in the number of appliances we use has significantly increased the amount of electricity we demand. At the same time, growing business reliance on electronic systems and processes has made our economy and community more reliant on power than ever before.”
In addition, he points out: “The need to replace ageing infrastructure at a time of increasing capital costs means that the overall costs of supplying electricity in Australia today is under intense upward pressure.”
Pierce sees the AEMC task, and this is equally true for politicians in government, as being “to put in place energy market arrangements that are most likely to deliver efficient, reliable supplies to customers over the long term under a wide range of future states of the world.”
The short, but profoundly important question, needing to be asked against this background is whether the we have the energy policy decision-making process right for 21st century Australia?
My colleague Robert Pritchard, executive director of the Energy Policy Institute. Is asking whether this country could benefit by having a well-resourced, independent National Energy Commission, unconstrained by politics, set up to work speedily, pro-actively and transparently to facilitate strategic energy and infrastructure development? Does Canada’s National Energy Board provide a model, he asks?
Pritchard has this question on the agenda for the “Energy State of the Nation” forum that EPIA is running on 22 March in Sydney. He has both Martin Ferguson and Ian Macfarlane on the speaking panel.
It will be more than interesting to hear what they think, not least because a study undertaken by EPIA and KPMG has exposed a “sub-optimal environment” for financing the scores of billions of dollars needing to be spent in this country for the energy sector between now and 2030.
Keith Orchison
4 March 2013
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