Issue 32  August  2007

Shock of the new

When Professor Tony Owen's report on generation development to the New South Wales Government is published it will be interesting to see how much attention he gives to what may turn out to be the biggest issue for new power plant developers, government or private, in the next decade: construction prices.

The global power sector is confronted by massive inflation in the cost of copper, nickel, stainless steel and concrete, essential materials in generation capacity construction, as well as in the cost of manufacturing metal components. Siemens, one of the world's largest power manufacturers, has estimated that the costs of building coal-fired plant have shot up 25 to 30 percent in 18months. It also reports that the cost of providing high-pressure piping in combined-cycle natural gas plants has risen 60 percent in two years.

The renewable energy sector is no better off -- price rises for copper and steel as well as fabrication are driving wind turbine costs inexorably upwards.

Given the time needed to move power station proposals from initial planning to commissioning, investors are finding, to quote a US consultant, that capital costs are doubling before they stick a shovel in the ground.

Price of drought

If it happens to fruit and vegetables, you shouldn't be surprised if it happens to power. That's the message from generators to governments and the community in response to high and volatile national electricity market prices as a result of the drought.

In a briefing paper, the National Generators' Forum argues that market reform has worked as planned in the 1990s and effectively eliminated large-scale excess generating plant capacity. There is now, it claims, adequate investment in plant capacity to match demand. "This is the market operating as it was intended (but) there is very little generating capacity lying idle."  As a consequence the NEM will "exhibit volatile prices when there are major disturbances to its equilibrium," such as the drought curtailing some supply in eastern Australia.

The Forum notes that NEMMCo August update on the drought impact for the Ministerial Council on Energy indicates continuing low rainfall will cause further capacity reductions in Queensland until the second half of next year when recycled water becomes available and significant capacity impacts in Victoria. In this scenario, energy reductions will roll on in to the first six months of 2009 at levels between four and six percent of NEM production.  Average rainfall will ease these reductions, but not eliminate them.

Options for managing the situation, the NGF suggests include increasing plant efficiency to deliver higher generation output without increasing water demand, using lower quality water such as treated and recycled effluent and resorting to dry (or air) cooling for new thermal power stations.  The downside of air cooling is that it reduces the efficiency of thermal power stations and pushes up both capital and operating costs.

Governments, the NGF argues, should not give in to pressure to intervene in the NEM to curb volatility. This will distort both consumer prices and investment patterns. Energy-intensive manufacturers, who have been loud in their complaints about the 2007 situation, should better manage their hedging contract arrangements. Consumers generally should be more efficient in their use of power, especially in peak periods, and should be better informed about the market drivers.

Cost of abatement

Consultants ACIL Tasman have calculated that driving half the existing coal-burning generation plant out of the Australian market to radically cut greenhouse gas emissions would require a carbon charge of more than $50 per tonne of CO2, leading to $30 to $40 per MWh increases in retail power prices.

In a presentation to the JP Morgan investment seminar, ACIL Tasman executive director Paul Balfe has predicted that a "business as usual" scenario, with relatively modest abatement measures commencing in 2010, would see annual demand by the generation sector for gas almost treble from today's levels to 440 petajoules a year. This would see emissions from electricity production still rising -- from today's 175 million tonnes a year towards 240 Mt annually.  Large-scale use of gas under higher carbon charge scenarios designed to cut emissions below present levels would push gas demand to between 1,200 PJ and 1,600 PJ, necessitating a substantial increase in gas reserves available on the eastern seaboard.

Reserve growth

Energy analysts EnergyQuest report that "2P" (proved and probable) gas reserves on Australia's east coast stood at 14,900 PJ at the end of June, reflecting steady increases in the reserves of coal seam methane being identified in Queensland.

New discoveries offshore Western Australia drove up natural gas reserves on the west coast to 26,250 PJ.

National gas production for the financial year shot up 8.9 percent as a result of both the impact of the drought on demand in the eastern States and rising exports of LNG. Gas use for power generation in eastern Australia more than doubled in 2006-07, says EnergyQuest CEO Graeme Bethune, to offset the fall in coal-burning electricity supply resulting from water problems in Victoria and Queensland.

More Bass gas

ExxonMobil says it and BHP Billiton have added approximately a trillion cubic feet of natural has to existing reserves in their Gippsland Basin leases in Bass Strait through drilling activities since 2004, enough to fuel power production for a city the size of Adelaide for 20 years.

'Easy gas' gone

Keith Spence, Woodside Enenergy's director, enterprise capability, has bluntly told complaining energy-intensive businesses in Western Australia that "the easy gas has gone." 

There has been a furious WA debate for months over the availability of natural gas for the domestic market and its price for large users. Energy-intensive companies, banded together as the DomGas Alliance, argue the gas market has failed and government intervention is needed to safeguard supply.

Spence retorts that, as a result of the resources boom in the West,  the market has outpaced the supply industry's short-term ability to meet increased demand, but critics need to understand that the State has abundant gas, located further offshore and available only at higher cost. 

WA gas prices, he adds, have "not even remotely" kept pace with the rise in global energy prices. "The claim that the price of WA gas is uncompetitive is grossly out of line."

Coal burning

Black coal burning by power stations in New South Wales and Queensland passed the 52 million tonnes mark in 2005-06, according to the latest Energy Supply Association yearbook.  With electricity consumption climbing at the rate of 2.9 percent a year, black coal use has jumped by five million tonnes a year in the five fiscal years since 2002 while brown coal demand has risen by 2.5 million tonnes a year in South Australia and Victoria to get close to 70 million tonnes annually.

The association says black coal is meeting 58.7 percent of national electricity generation versus 25.2 percent for brown coal.

It reports that black coal plant in NSW emitted 920 kilograms of carbon dioxide equivalent per megawatt hour sent out in 2005-06. The Queensland level was 894.7 kg

-- while brown coal plants in Victoria emitted 1,383.1kg per MWh.

ESAA forecasts that generation sent out, which reached 206,000 gigawatt hours in 2005-06, will be about 250,000 GWh by 2016.

Autogas on a roll

The Federal Government has shelled out $139 million in subsidies in 2006-07 to promote LPG as a transport fuel and, as a result, 70,000 consumers have bought Autogas-fuelled vehicles or had existing vehicles to converted from petrol use. The subsidy program is scheduled to run for eight years and to cost taxpayers almost $700 million. The scheme gives motorists who convert petrol-driven vehicles to LPG a tax-free subsidy of $2,000 and provides $1,000 towards the cost of new LPG vehicles.

Lobby group LPG Australia says it expects the subsidy to drive up the conversion market from 45,000 vehicles a year before the scheme was introduced to 107,000 this calendar year and to increase sales of new LPG vehicles from 15,000 a year to 30,000.

Hot rock potential

Nascent heat miner Geodynamics has reminded the Owen generation inquiry for the NSW Government that Cooper Basin hot frasctured rock resources are expected to provide 500MW of baseload capacity for the national electricity market by 2014-16 and another 3,500 MW by 2030. It was responding to submissions to the inquiry by others talking down the potential for geothermal energy.


It would be more than a little helpful if the major political parties could agree on a set of principles for greenhouse gas abatement policy before the federal election is held.

A highly unlikely prospect in reality, no doubt, but a step that would go a long way to providing investors -- and especially those considering new energy supply projects and energy-intensive manufacturing developments -- with a far better sense of security than they have today.

Uncertainty is an inevitable consequence of the trajectory climate change policy is taking in Australia.

The details of the now-certain domestic emissions trading scheme will be complex and probably take 3-4 years after the election to develop.  This  means that the scheme will still be at least partly "in play" when the 2010 federal election is held --  a thought unlikely to make too many business people very happy.

The interplay of emissions trading and other greenhouse programs such as the mandatory renewable energy target scheme also will need to be resolved. 

As well, the inevitable lack of a a global trading process  will continue to threaten the trading position of Australia's energy-intensive manufacturers.

Nonetheless, the major parties could reduce the jitters for investors by agreeing on some fundamental principles. Here are five that would go a long way towards achieving a (relative) calming effect:

1. All abatement policies must be cost-efficient. Policies that impose costs without substantially improving the environmental situation should be rejected. Cost efficiency needs to extend to minimised administration and transaction burdens.

2. Policies must allow businesses to maximise flexibility and choice of abatement technology to achieve emission cuts with the greatest equity and the lowest cost.

3. Policies must not undermine the international competitiveness of trade-exposed Australian businesses by increasing their costs relative to costs in rival countries.

4. Costs must be borne equitably across the community and not disproportionately by some businesses and some sectors.

5. Adequate compensation must be paid to significantly disadvantaged businesses.

None of this is rocket science and various elements of the business community have been putting forward these concepts in differing forms for years.

The core problem is that the parts that matter of the body politic -- that is the parties capable of forming government as opposed to the fringe dwellers, the populists and ginger groups -- have not managed to clearly embrace these principles so that the investors can have confidence that, whoever is in power federally, they will not have to endure years of an ongoing mish-mash of policies and kneejerk reactions by government.

Keith Orchison

28 August 2007

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