Commentary

 

Issue 113, September 2014

Welcome to the September issue of this newsletter, writes Keith Orchison, as the row over the RET rolls on and the Eastern Australian Energy Market Outlook conference prepares to debate the critical concerns of key east coast energy stakeholders, including growing fears about the longer-term reliability of the NEM and the impending gas crisis in New South Wales.

Watch on NEM

There is a growing concern among some east coast market participants that insufficient attention is being paid to the long-term reliability of the NEM in an environment where policy continues to force in capacity, large parts of the coal-fired fleet are reaching the end of their normal useful life, there is no relief in sight on barriers to exit for outdated plant and revenue woes are forcing generation owners to reduce maintenance spending.

Industry Minister Ian Macfarlane says there is currently “about 9,000 megawatts” of surplus generation capacity in Australia.

The issue is slated for discussion at the “NEM Future Forum” that forms part of the 2014 Eastern Australia’s Energy Market Outlook conference in Sydney from 16 to 19 September.

Market observers are pointing to the fact that even a decision by the federal government, assuming subsequent approval by the Senate, to amend the renewable energy target could still see more wind energy added to east coast capacity by the start of the new decade.

There is concern that policymakers are poorly informed about the potential consequences of failure to manage both the retirement of conventional plant from the NEM and how and when it should be replaced to ensure continuing system security.

Stakeholders are starting to make a case for the Australian Energy Market Commission to be required by the Council of Australian Governments’ energy ministers committee to report on ageing electricity generation infrastructure in in an era of declining energy demand, substantial capacity over-supply and low wholesale prices.

The AEMC can’t initiate such a review off its own bat; a move is required by CoAG and some NEM participants are concerned that there is no sign of ministerial interest in the issue.

The industry will be watching Ian Macfarlane’s 10 September address on the energy policy state of play to the Committee for Economic Development of Australia (CEDA) for signs of appreciation of this problem presently lurking in the background of the at times frenetic debate on carbon policies and the RET in particular.

The commission itself has published a carefully-worded warning to policymakers in its submission to the Harper review of competition policy, but there is concern in some quarters that the message may pass by key politicians at federal and State levels.

The AEMC told Harper: “Policies aimed at meeting a climate change objective may conflict with the ability of an energy-only market design to send meaningful price signals for new investment in generation capacity, which is arguably the central policy objective (of the NEM). This, in turn, may undermine future supply reliability.

“The operation of the RET in its current form has led to wholesale market price outcomes divorced from underlying energy supply and demand fundamentals – wholesale prices are very low, yet new capacity is still entering the market.”

ESAA view

In its 2014 yearbook, published in August, the Energy Supply Association also urges policymakers and regulators to look beyond the short-term generation over-supply issue.

The association says: “There is a question whether in the longer term the current market setting will sustain electricity supply to meet demand.

“The continued roll-out of renewable power, resulting in the likelihood that flexible plants will be pushed out of the market (in part due to higher gas prices) while baseload plants remain to balance the growing intermittent generation, suggests the current (NEM) market settings may not sustain the appropriate price signals for investment in flexible and reliable energy capacity.”

ESAA goes on to point out that its annual list of proposed power station plants remains long “but there is significant uncertainty over almost all of them, even those that have received planning approval.”

EWP delay

A throw-away line in a newspaper interview with Industry Minister Ian Macfarlane has confirmed what some policy watchers had come to believe in mid-2014: the task of publishing a new energy white paper by late this year is proving too hard and the federal government is now looking to the early months of 2015 – halfway through its current parliamentary term – to unveil it.

Wrestling with the report of the Warburton panel review of the RET, which reached the Prime Minister in early August, and needing to resolve how to address changes to renewable energy policy in a manner that could attract sufficient Senate votes for amending legislation, the government must also produce a promised energy green paper and get reactions to it before moving to the final EWP.

The white paper delay is not surprising: both the 2004 (Howard government) and 2012 (Rudd/Gillard government) efforts at producing similar policy overviews ran well over the initially targeted publication deadline.

Some energy policy observers are still puzzled that the Abbott government chose to relaunch the whole EWP process when it won office in late 2013 rather than dissecting the 2012 paper produced by former Energy Minister Martin Ferguson, updating parts of it overtaken by events and producing a detailed outline of its own approach by mid-2014, including its intentions to amend the RET.

Instead, the government has buried itself in issues papers, hundreds of submissions to reviews, the inevitable fiery debate in the media and no real action apart from its eventual success in having Parliament axe the carbon tax.

Macfarlane told “The Australian” newspaper in late August that “the energy position paper was originally due later this year but is now likely to be released earlier next year.”

He said the delay is to “take account of what comes from the RET review.”

RET-go-round

The renewable energy target saga moved to a new level at the end of August with the release of the Warburton review panel’s report, which concludes that the cost of the scheme to the community outweighs its benefits and that significant change is required.

The environmental movement’s reaction was encapsulated by the Climate Institute’s response that the panel proposed “cutting investment in renewable energy off at the knees, entrenching fossil fuel subsidies, endangering the growing clean energy industry and blowing another hole in climate policy.”

The panel says that the RET is providing an incentive for investment in generation that is not required by the market and is not viable without a substantial cross-subsidy funded by “a wealth transfer from incumbent generators, energy retailers and consumers.”

Industry Minister Ian Macfarlane and Environment Minister Greg Hunt said the government would announce its response to the report “in coming weeks,” adding it was determined to ensure energy markets “remain robust and reliable.”

Numbers game

Modelling undertaken by consultants Jacobs Group for a trio of environmental activist lobby groups shows that reducing the renewable energy target from its current 41,000 gigawatt hours by 2020 level to a floating “true 20 per cent” of consumption would see cumulative carbon emissions from power stations increase by 150 million tonnes over 15 years.

However, it would take some $13 billion in extra capital investment to achieve the additional abatement.

The Jacobs study asserts that retention of the RET at 41,000 GWh would see $18.88 billion of capital expenditure between 2015 and 2020 plus $4.7 billion through the first five years of the next decade and $806 million between 2025 and 2030. By contrast cutting the RET to a “true 20 per cent” – delivering an estimated 27,000 GWh of green energy in 2020 – would require $6.9 billion spent between now and 2020, a further $3.6 billion outlayed from 2021 to 2025 and $806 million in the last five years of the next decade.

The consultants calculate that cumulative emissions from power generation will be 2.9 billion tonnes in 2030 if the RET is retained at its present level and 3.06 billion tonnes under a “true 20 per cent” regime.  Emissions on average would be about 10 Mt a year higher is the federal government proposes the lower target and can persuade the Senate to approve it.

The consultants acknowledge that actual electricity demand could be “significantly lower” than the level they have used as a base case in their modelling.

Jacobs’ modelling indicates that the State where renewable generators’ hopes for investment would be hardest hit by a reduction in the RET to a “true 20 per cent” would be New South Wales – where the Baird government has recently said it wants to emulate California in pursuing renewables use.

According to the consultants, the present RET would see $6.2 billion in investment in NSW between 2015 and 2020 and none thereafter out to 2030 – while a reduction in the measure to a “true 20 per cent” would see $1.7 billion spent in the final years of this decade and a further $391 million outlayed in the first five years of the next decade.

Another Coalition-governed State that has spoken up strongly for retention of the RET at its present level is Tasmania – where, according to Jacobs, the current scheme would see almost $2 billion in investment in the next five years (and none thereafter to 2030) while a shift to a 27,000 GWh target would see renewables investors spend $978 million from 2015 to 2020 and $980 million from 2021 to 2025.

In South Australia, the consultants report, retention of the RET at its present level could result in $5.3 billion being spent in the next five years compared with and outlay of $816 million over the rest of this decade and $1,149 billion during the ‘Twenties.

These numbers have received no coverage in widespread media reporting of the chief propaganda line of the environmental trio, using the Jacobs report: that generator profits would be $11 billion higher in aggregate over 15 years if the Abbott government succeeded in reducing the RET to 27,000 GWh – due to a postulated rise in wholesale electricity prices and an increase in energy output levels for incumbent power stations.

The Sydney “Daily Telegraph” in a typical tabloid “shock, horror” report headlined “A $10 billion power bill rip-off as families to be hit with another increase” declaimed that “families are to be hit with another big power bill increase, slugging mums and dads” before revealing the Jacobs report estimates the rise at $30 annually on average household charges – or 8.2 cents per day.

In a media commentary, the Climate Institute, one of the trio of Jacobs’ clients, acknowledges that the postulated extra cost for households is in fact “fairly minor” while arguing that “weakening the target benefits power companies rather than consumers.”

What is missing from both the “Telegraph” story and the Climate Institute commentary is a simple piece of arithmetic: A $30 per year annual increase in costs multiplied by 9.34 million residential customers across Australia equals $280 million a year in higher bills – and this, multiplied by the 15 years from 2015 to 2030, represents an aggregate $4.2 billion in costs, not $10 billion.

The balance of the aggregate higher charges mooted by the modelling would fall to manufacturers and the commercial sector, not “mums and dads,” and they are broadly united in calling on the federal government to reduce the RET, mainly speaking out for a “true 20 per cent” because, overall, they stand to benefit substantially, especially those companies in trade-exposed areas, from the change.

 

Whose risk?

The Jacobs Group report on impacts of changes to the RET notes that the east coast market structure has changed markedly over the 15 years the NEM has been in existence.

Three gentailers (Origin Energy, AGL Energy and EnergyAustralia) now service 80 per cent of the electricity retail sector, the consultants note, and effectively have the majority of the RET liabilities – and the main businesses with who green generation proponents need to write power purchase agreements.

Without these PPAs, Jacobs add, renewables investors would need to take market price risk, obtain financing from other sources or fund their projects on their balance sheets.

Blame game

Green social media leapt on the latest failure of plans for a large solar power plant at Mildura to blame the Abbott government’s RET review and mainstream media seemed happy to go along for the ride at the end of August.

But this is what Silex Systems chief executive Michael Goldsworthy told the local Victorian ABC radio station: “We’re keeping out of the blame game. We just had to make an economic decision, a business decision, on whether the project could be funded.”

While uncertainty over the RET was a factor in the decision, Goldsworthy said, low wholesale electricity prices in the NEM (something RET boosters have been boasting about bringing about) also contributed. “We just couldn’t make those ends meet.”

The move to shelve the 100MW concentrating photovoltaic development is not the first big pothole in Mildura’s ambitions to become Australia’s capital for utility scale solar power.

The initial idea for a $420 million power plant was conceived a decade ago and launched in 2006 with much fanfare by the Howard and Bracks (Victorian) governments plus an offer of $125 million in subsidies ($75 million in federal funds).   

The development was supported by TRUenergy (now EnergyAustralia), which paid $40 million for a 20 per cent stake – but it walked away in 2009 when its owner, Hong Kong’s CLP, wrote off the investment

By 2010 the economic situation after the global financial crisis had wrecked the initial project.

The latest attempt was supported by a new $75 million federal grant through the Australian Renewable Energy Agency and $35 million from the Victorian Energy Technology Innovation Strategy Fund.

Again, the subsidies have proved insufficient to keep the venture alive.

Silex said in July that it was “accelerating” efforts to find a business partner for the Mildura development whose involvement would potentially eliminate the need for it to invest further money as it pursued a strategy to “reduce cash burn” and pursue its main interest in uranium processing technology.  Apparently these efforts were unsuccessful.

Now, Goldsworthy, whose company took over the original Solar Systems business in 2011, says work on an alternative Mildura project, a scaled back version, is “already under way.”

ARENA says it is “open” to another go at the development.

Biggest concern

While debate rages in the mainstream and social media over the fate of the renewable energy target, Industry Minister Ian Macfarlane has revealed in a newspaper interview that his biggest concern in this part of his sprawling portfolio is the impending crisis in east coast domestic gas supply centred on New South Wales.

The Industry Department published a strongly-worded review of the east coast gas market soon after the Abbott government came to office. It was
the product of a study launched by the Gillard government, at the behest of newly-appointed Energy Minister Gary Gray, in May 2013.

However the review has been absorbed in to the Abbott government’s energy white paper process and virtually all of 2014 will be lost before the new regime’s views can be expected to appear in the energy green paper.

Macfarlane is expected to focus on the issue when he addresses CEDA in Sydney on 10 September.

Meanwhile, he has told “The Australian” newspaper that “the arrival of the crisis in 2016-17 is now close; NSW is just not going to be able to get the gas.”

It is a measure of the peculiar state of media focus on energy policy at present that Macfarlane’s renewed exposure of his concern – he has spoken out about the problem numerous times over the past 2-3 years – was comprehensively ignored beyond the initial newspaper report.

Macfarlane told “The Australian” that “even if all the planets lined up and everyone started drilling frantically in NSW, (the gas) is not going to be developed and taken to market in time.

“What’s going to happen when thousands of people start losing their jobs because there is not enough gas in NSW?” he asked.

“Some people,” he added, “have tried to put their heads in the sand and pretend that this is not going to happen. But this is real, this is here and now.”

The only related news from the State government in late August was an announcement by Energy Minister Anthony Roberts that monitoring of groundwater in areas where there is strong coal seam gas commotion will be increased “to ease community concerns.”
Earlier in the month Roberts had announced approval for AGL Energy to undertake a pilot program to flow test CSG near Gloucester.

The radical environmental opposition to CSG immediately announced it would blockade the test site.

The Australian Petroleum Production & Exploration Association said water monitoring strategies are at the forefront of existing industry operations.

“In Queensland,” APPEA asserted, “where projects worth almost $70 billion are under way to source gas from coal seams, extensive monitoring by government and industry has shown the impact on groundwater resources to be negligible.”

The association added that water from the CSG operations in Queensland is being treated for use on farms, for livestock and to supplement town water supplies.

In a newspaper interview in Melbourne, Origin Energy managing director Grant King said the CSG industry has been subjected to a prolonged scare campaign but he believed “science is beginning to win out over myth.”

He pointed to a new CSIRO report that fugitive emissions are low from CSG wells as another example of “how facts speak for themselves.”

King added: “The body of evidence is overwhelming the body of misrepresentation.”

No protection

Vince Graham, chief executive of the trio of New South Wales trio of government-owned electricity distribution businesses now grouped as Networks NSW, has set out to “bust the myth” that public ownership protects householders from higher power bills.

In a newspaper commentary and a panel discussion forming part of the televised “Powering Australia” forum, Graham says that Sydney residential network charges are $200 a year higher than for Melbourne households.

Annual operating costs per customer for NSW networks are 60 per cent higher than in Victoria, he adds.

The problem, he described on a Sky TV program, has been “almost a Bermuda Triangle for consumers in NSW where you have public ownership, politically powerful unions and compliant management leading to very high cost structures.”

Two years of “sweeping reform” under the NSW Coalition government, Graham says, have seen the capital budgets of the network trio he oversees slashed by $2.2 billion, but reducing labor costs is more difficult.

He identifies two “systemic issues” associated with public ownership that have contributed to higher NSW network costs: (1) stronger financial discipline in networks owned by investors and (2) the unions and previously “amenable” management in NSW combining to deliver workplace agreements driving higher labor costs.

He accuses the trade unions of exercising a “shadow management” role in the networks for many years to entrench “unproductive” work practices and says removing or rolling back these arrangements is “challenging” under the Fair Work Act.

He also accuses the unions of having spent two decades opposing a change of ownership for NSW networks to protect their labor monopoly, pointing out that the greatest threat to employee security is agreements that “eventually will drive the outsourcing of existing jobs.”  The change, he adds, is inevitable.

The Baird government in NSW hopes to sell 49 per cent of two of the trio of State-owned networks – Ausgrid and Endeavour Energy – after next March’s election. Premier Baird has had to shelve plans to also sell the rural Essential Energy business in the face of opposition from his Coalition partner, the Nationals.

The networks trio are pursuing new revenue determinations from the Australian Energy Regulator at present in which they propose capex and opex outlays between 2014 and 2019 that will result in an average end-user bill rise of two per cent a year, far lower than the spikes of the past five years.

In their joint latest submission to the AER, the networks say they have each embarked on efficiency drives to ensure that the impacts of their new plans on customers are minimized.

They point out that, despite the substantial replacement program undertaken in 2009 to 2014, the average age of the networks continues to increase and the replacement program must continue – as well, while the fall in consumption is expected to continue and peak demand growth should slow or fall, growth in customers requiring connection means that capital outlays must continue.

What we want

Consumer research undertaken by the New South Wale electricity networks as part of their 2014-19 regulatory submissions has thrown up three top priorities for mass market customers.

Affordability remains the top requirement: a “consistent and very strong message” is that households and small businesses want an end to rapid, steep increases in their bills.

Reliability remains a high concern: customers don’t want to pay more for greater reliability but they are not prepared to trade off poorer reliability for lower prices.

The third consumer priority is safety: customers “hold strong views” that networks should be run safely and are not prepared to trade off safety for lower prices but they also don’t want to pay more for a greater focus on public safety campaigns

Small change

Carbon and energy analysts Pitt & Sherry report that annualized electricity demand on the east coast in the 12 months ending July saw the first increase since March 2013 and the first significant increase in generation-related emissions since October 2011.

The firm says electricity demand increased in all States forming the NEM except Victoria.

“It is possible,” they comment “that some consumers may have increased
consumption in the expectation that electricity would be cheaper )after the repeal of the carbon tax); alternatively colder than average winter temperatures may have been a factor.”

Looking at emissions in the NEM since they peaked in December 2008, Pitt & Sherry say they have fallen 18 per cent as a result of a decrease in coal-fired generation.

They claim reduced consumer demand has accounted for 49 per cent of the total emissions reduction, increased gas generation nine per cent and increase use of hydro-electric power and wind farms have each contributed 19 per cent.

Four per cent of the emissions fall, they say, can be attributed to a rise in the average thermal efficiency of coal plant as older plants have lost market share or been withdrawn from supply.

Pitt & Sherry add that the policy, technology and consumer demand factors affecting the market “remain highly dynamic.”

 

Last word

There have been a bunch of recent media stories, some of them written locally, about a new Citigroup “Energy 2020” commodities paper with all focusing on a theme encapsulated by headlines like “super-bullish about solar” and “outlook for solar is getting brighter.”

What readers haven’t told in these stories is that the 64-page Citi report ranges much wider and is no less bullish about the future of shale gas and tight oil production.

A synopsis of this side of the paper might go like this, quoting Citigroup:

There is little doubt that the tremendous lead of the US as a producer of unconventional hydrocarbons will grow over the rest of the decade.

It might also be foolish to underestimate the spread of the “shale revolution” internationally even before the end of the decade.

(Interesting reading when one recalls that “respected” international analysts were being quoted in the media quite recently about shale gas being a “bubble.”)

Where you don’t have landowners also controlling mineral rights (as they do in the US), says Citi, Canada is a strong example of how to attract shale gas investment because “its overall tax structure is benign and constructive” and its provincial governments have substantial stakes in revenue from production.

“Canada is not alone in this regard, Australia’s Cooper Basin holds significant promise for large scale and rapid growth before the end of this decade.”

(Now how did you miss the local media headlines heralding this Citi promise of another chapter in the Australian energy revolution? Easy. There haven’t been any.)

Look also to China (yes, the country whose renewables revolution keeps making local headlines), say the analysts, because, with an estimated 1,115 trillion cubic feet of recoverable shale gas, the Chinese “sit in the top ranks of reserve holders along with the United States.”

Other countries where we may see a strong focus on a shale gas industry are Argentina, Mexico, Russia and Saudi Arabia.

“It looks as though current global shale production outside the US could easily double by 2020, perhaps more than treble and the world might then be ready for a take-up like the one we have seen in the US.”

However, the hurdles to this happening are “enormous,” driven as much by fear as carbon concerns.

In short, “the geology is promising and abundant globally but geology alone is not sufficient to generate a US-style revolution. What’s needed are a good legal framework, developed infrastructure, a robust services industry and accommodative credit conditions.”

The paper also contains some interesting thoughts on Australian gas export prospects.

For a start, Citigroup says:

“The long-held order of global gas supply and demand look likely to be up-ended with sharply higher US exports altering the existing geopolitical balance.”

If the economics work out, total North American exports could easily surpass 12 billion cubic feet per day by the end of the decade.

Meanwhile Australian exports, it says, are expected to reach 10.8 bcf/d by 2020 (that’s 83 million tonnes of LNG a year, up from 26 Mt now).

However, local costs pressures here are seen as a big threat to this outlook. High-cost projects here and anywhere else globally that have not gone ahead already “may face more headwinds in obtaining capital, signing contracts and receiving favorable terms.”

Asian LNG prices could fall from $US15 to $18 per MMBtu to the lower end of $US11 to $14, near the delivered cost of Russian gas to the Chinese (by pipeline) and of American gas in to this regional market.

The surge in Australian supplies, Citigroup comments, should be the first test of Asian appetites in this new era as supplies from here ramp up before the US gets going and the Russian activity ramping up only at the decade’s end.

Then, it adds, “successful deployment of inexpensive floating LNG could have a large impact in terms of moving Australian projects down the cost curve, unlocking vast offshore resources in the process.”

Lastly, Citigroup offer some interesting thoughts on American electricity generation:

There is an evolution unfolding as a result of two transformations: regulatory and technological.

Regulations are helping to push older, inefficient coal plants in to retirement – with 61,500 megawatts of capacity projected to close down (out of some 300,000 MW of coal plant) – while US nuclear units, most of which have run for decades, now face stricter safety measures post-Fukushima.

Meanwhile technological advances are altering electricity demand as lower costs allow renewables to proliferate and the power of shale gas (for electricity) is being unleashed.

The challenge for gas in fuelling US power generation will come from renewables, especially in a slow demand growth environment.  What is critically important as this happens, says Citi, is stable grid operation as variable generation grabs a larger share of the market.

“Operating characteristics (between renewables and gas and coal power) are very different from each other.”

Citigroup makes the point that the known unknown here is the future price of gas in the US.

If gas prices go high, coal plant will benefit, at least in the short term.

If this happens, electricity-related emissions reduction in the States from now to 2020 may be only about 200 million tonnes compared with a fall of 420 Mt in the past six years.

It could be some years, asserts Citi, before an inflection point is reached in America where the capacity of renewables in the power system significantly erodes the profits of conventional generation.

Whatever happens, the bank analysts also say, there is unlikely to be a reversion to the long-term growth rate of US generation development of two per cent a year – but then a big take-up of electric vehicles could be a game-changer.

However, Citigroup does not expect a significant penetration of EVs in to the American fleet in next seven or so years.

This is all interesting stuff and it would be useful for it to be communicated to the Australian public and especially opinion-makers and policy advisors here but, for the most part, journalists seem to have the sun in their eyes when they look at reports of this kind from overseas.

Keith Orchison
1 September 2014

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