THE PERFECT STORM: ANALYSING THE ROLE OF GAS IN SOUTH AUSTRALIA’S POWER PRICES
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Published by the Climate Council of Australia Limited ISBN: 978-0-9953639-1-5 (print) 978-0-9953639-0-8 (web) © Climate Council of Australia Ltd 2016 This work is copyright the Climate Council of Australia Ltd. All material contained in this work is copyright the Climate Council of Australia Ltd except where a third party source is indicated. Andrew Stock Climate Council of Australia Ltd copyright material is licensed under the Climate Councillor Creative Commons Attribution 3.0 Australia License. To view a copy of this license visit http://creativecommons.org.au. You are free to copy, communicate and adapt the Climate Council of Australia Ltd copyright material so long as you attribute the Climate Council of Australia Ltd and the authors in the following manner: The perfect storm: Analysing the role of gas in South Australia’s power prices by Andrew Stock and Petra Stock.
The authors contain sole responsibility for the contents of this report. — Petra Stock Image credit: Cover photo "Where Adelaide's Electricity Comes From" by Energy Systems Flickr user Michael Coghlann licensed under CC BY-SA 2.0. Researcher This report is printed on 100% recycled paper. Climate Council
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Contents
Key Findings...... i
1. Introduction...... 1
2. South Australia’s Transition to Renewable Power is in Line with Climate Change Action...... 2
3. The Anatomy of a Price Spike...... 4
4. Outcomes...... 11
5. Solutions...... 20
6. Conclusion...... 23
Appendix 1 24
References 25
Image Credits 26 ii THE PERFECT STORM: ANALYSING THE ROLE OF GAS IN SOUTH AUSTRALIA’S POWER PRICES
Key Findings 1 3 Interstate controlled power ›› Collectively, these events created The media focus on renewable companies used the recent the perfect storm for prices to energy enabled the parties and interconnector transmission increase. reasons responsible for South line outage with Victoria Australia’s recent high price to exploit their strong gas ›› Analysis shows these power events to avoid public scrutiny. generation market positions companies appeared to engage There is considerable cause for in South Australia, driving in deliberately unpredictable regulators to review the recent up prices to extreme levels. bidding behavior in July 2016, events in South Australia. Renewable energy was used inflating the price of electricity as the scapegoat, but prime on both the wholesale spot ›› A review of how the power responsibility actually lies market and future hedge companies exercised their with profit maximization by contracts. market positions, specifically the power companies. their bidding activities and the removal of Torrens Island ›› Power companies have used 2 capacity during the period of international gas export prices the Heywood interconnector to increase power prices across South Australia’s gas outage, is warranted to the National Electricity Market. generators earned around $178 determine whether any steps million in net margin on the should be taken in respect of ›› Recent power plant closures spot market during the July that conduct. and “mothballing” in the state high price events. increased the local market ›› A review of why the electricity power of these companies. ›› Past behaviour suggests they market operator and regulators will seek to pass these high allowed the planned Heywood ›› The removal of the Heywood power costs, now reflected in Interconnector outage to take Interconnector during South futures market prices, through place at a time when AEMO’s Australia’s peak winter demand to South Australian industrial own long term forecasts compounded the situation, and retail customers. showed the state would need allowing two companies - AGL this interconnector during peak and Origin – to control 80% of ›› The higher power costs winter demand. gas power generated in South could amount to triple South Australia. Australia’s share of the Heywood Interconnector ›› During the most extreme expansion capital cost. demand days, AGL made some of its Torrens Island capacity “unavailable”. This amplified the market position of these few companies. KEY FINDINGS iii
4 5 6 Increasing reliance on South Australia needs more Regulatory and governance high-priced gas is not a competition from more structures of the National viable solution to reduce energy supply sources to put Energy Market (NEM) should power prices or to tackle downward pressure on power be reviewed to ensure climate change. prices. This means: they are fit to manage the transformation to an energy ›› Using more gas power in ›› More low cost renewable energy future focused around South Australia will not solve from a diverse range of sources, renewables. the price issue. Rather it will including increased solar reinforce it and make it worse photovoltaic and solar thermal, ›› The electricity transition by further entrenching the and more wind. underway to a low carbon market position of incumbents high technology future reducing competition. ›› Increased interconnector centered on renewables is the capacity by adding an interstate industries' biggest change and ›› It will increase reliance on link to New South Wales. challenge in over a century. the state’s ageing obsolete gas fuelled fleet, increasing ›› Encouraging in-state fast ›› The current infrastructure greenhouse emissions response energy storage and was not built on the back of including risks of fugitive demand management (for large the energy only market of the methane emissions – a potent energy users). last 15 years. Market design, greenhouse gas. Both are regulatory and governance contrary to national greenhouse structures should be reviewed gas reduction commitments. to ensure they are fit to manage the transformation underway. They currently are not.
climatecouncil.org.au 1 THE PERFECT STORM: ANALYSING THE ROLE OF GAS IN SOUTH AUSTRALIA’S POWER PRICES
1. Introduction
South Australia is at the forefront In July this year, South Australia experienced of efforts (both in Australia and a series of high wholesale electricity price globally) to transition the state’s spikes in one week, which some politicians power generation from fossil fuels and media commentators simplistically to renewable energy sources like linked to the state’s high proportion of solar and wind (Australian Energy renewable energy, particularly wind (For Council 2016). example, Australian Financial Review 2016; The Advertiser 2016a; The Australian 2016). This was incorrect.
The mistaken attack on renewables enabled the principal reasons and parties responsible for the high price events to slip under the radar and largely avoid public scrutiny.
This briefing paper analyses the role the “gentailers” (generator-retailers, companies owning both power plants and retail businesses) played in the high wholesale price spikes in South Australia, the lack of competition, and the conditions which enabled these companies to exercise the full force of their market power. For background, see the Climate Council’s initial analysis in our report “Mythbusting: Electricity Prices in South Australia” (Climate Council 2016).
The mistaken attack on renewable energy has enabled the parties and reasons responsible for South Australia’s recent high price events to largely avoid public scrutiny. CHAPTER 02 2 SOUTH AUSTRALIA’S TRANSITION TO RENEWABLE POWER IS IN LINE WITH CLIMATE CHANGE ACTION
2. South Australia’s Transition to Renewable Power is in Line with Climate Change Action
Last year, nations worldwide This is critical for Australia’s future given that (including Australia), agreed to act we are highly vulnerable to the consequences to limit global warming to less than of climate change, worsening bushfire two degrees Celsius at the United conditions, extreme heat, sea level rise and Nations Framework Convention on damage to iconic ecosystems like the Great Climate Change Conference of the Barrier Reef. Parties 21 held in Paris in December 2015 (the Paris Conference). Meeting Globally, the transition to renewable energy this goal requires all countries to is well underway. Annual investment dramatically reduce greenhouse gas in renewable energy is consistently emissions like carbon dioxide. outperforming investment in new fossil fuel power, and falling prices for wind and solar are driving record-breaking installations of renewable energy capacity - last year totaling 147GW (REN21 2016). 173 countries now have renewable energy targets in place, with many of the world’s largest emitters announcing plans to dramatically scale up their renewable energy efforts (Climate Council 2015).
South Australia’s transition away from fossil fuels to renewable electricity is consistent with action needed to avoid catastrophic climate change. Figure 1: South Australia’s Starfish Hill Wind Farm.
Australia has one of the lowest levels After more than a decade of consistent of renewable electricity generation of policies and targets encouraging more wind comparable nations. Despite renewable and solar power in the state, South Australia electricity generation reaching 14.6% in 2015, now leads the other mainland states with Australia’s electricity remains dominated by 41.3% renewable electricity - far ahead of the fossil fuels such as coal and gas (Australian next mainland states Western Australia and Energy Council 2015; Clean Energy Council Victoria at 12.1% renewable electricity (Clean 2016a). Producing electricity from fossil Energy Council 2016a; Figure 1). The state is fuels is Australia’s number one source of on track to reach its target of 50% renewable emissions - responsible for 35% of Australia’s electricity by 2025 (Government of South total greenhouse gas emissions (Australian Australia 2015). Government 2016). Research shows that Australia will need to source a minimum South Australia’s transition away from fossil of 50% of its power from renewable sources fuels, particularly coal, is consistent with by 2030 in order to achieve emissions action needed to avoid catastrophic climate reductions consistent with limiting global change. warming to less than two degrees Celsius (ClimateWorks 2015). CHAPTER 03 4 THE ANATOMY OF A PRICE SPIKE
3. The Anatomy of a Price Spike
In the week of 7 - 14 July, a number of circumstances coincided creating the “perfect storm” for South Australia’s “gentailers” (generator-retailers, companies owning both power plants and retail businesses) to exercise their market positions – and raise wholesale electricity prices dramatically.
A number of factors contributed to high electricity prices in the week of 7 - 14 July 2016:
1. Existing market position of the 4. The removal of the Heywood gentailers: In South Australia, the Interconnector during peak winter electricity market is dominated by a small demand further compounded the number of companies who control both situation: The main electricity line the production (owning the in-state gas connecting South Australia with Victoria power plants) and sale (owning the major (known as the Heywood Interconnector) electricity retail businesses) of electricity. was in large part, removed for upgrade Energy regulators have expressed works. The interconnector was removed concerns about the lack of competition in at a time of peak winter demand, which South Australia’s electricity market together with the generator withdrawals, for years. took out 1700MW of supply. The removal of the Heywood Interconnector removed 2. Already expensive gas power prices: a key source of competition in South The price of power generated from Australia’s electricity market, giving the gas has increased around Australia local gentailers more pricing power. underpinned by international gas prices since liquefied natural gas (LNG) exports 5. Local gas generation capacity was made commenced. unavailable during this period: AGL made parts of its Torrens Island capacity 3. Power plant closures or “mothballing” “unavailable” during the most extreme further concentrated the market shares demand days. With even less local of the gentailers: The closure of Alinta’s generation capacity, supply and demand Northern and Playford coal-fired power came closer together, further increasing stations and the “mothballing” (taking the pricing power of the local gentailers. out of service for a period) for winter 2016 of Engie’s Pelican Point gas plant 6. Bidding behavior of the gentailers collectively, reduced South Australian maximised their financial returns. Based generating capacity by around 1250MW. on available evidence, these companies This brought supply of electricity much appeared to engage in deliberately closer to demand. When supply and unpredictable bidding behavior to inflate demand are closer together, there is less the price of electricity far above cost on competition to supply electricity and the the wholesale spot market. The high spot pricing power of the gentailers increases. prices are being reflected in future hedge contracts (which usually allow users to reduce price risk), and will likely lead to increased consumer retail prices. 5 THE PERFECT STORM: ANALYSING THE ROLE OF GAS IN SOUTH AUSTRALIA’S POWER PRICES
In summary, the existing market position of a Each of these factors is explained in more small number of gentailers in South Australia detail below. was increased by a series of circumstances - power plant closures and mothballing Existing market power of the bringing supply and demand closer together. gentailers The removal of the Heywood Interconnector and some Torrens Island gas capacity Energy companies are able to exercise compounded the pricing power of these “market power” (meaning the ability to set companies. high prices) in states where there are few companies operating, reducing competition. While wind and solar provided some of These companies are also “gentailers”, South Australia’s power during this period, owning both power plants and electricity the restricted capacity of the interconnector retail businesses (this is sometimes referred meant the state was more reliant than usual to as vertical integration). on gas to meet the remaining demand (Clean Energy Council 2016b). “High levels of market concentration and vertical integration between generators In this situation, the gentailers exercised the and retailers give rise to a market structure full force of their market position by using that may, in certain conditions, provide unpredictable bidding patterns designed opportunities for the exercise of market to increase the price of electricity far above power.” cost. This led to gas power prices reaching - Australian Energy Regulator 2014 extreme levels, and gas generators earning an estimated net margin of around $178 Competition concerns have been expressed million in the spot market over the fortnight for years by regulators about the South (RenewEconomy 2016c). Australia’s highly concentrated market for gas fuelled power generation.
“The Commission’s analysis has demonstrated that South Australia may The existing market have some characteristics that may make it different from other [National Electricity positions of a small Market] regions and potentially more prone to inhibiting efficient investment number of gentailers and promoting the likelihood of substantial market power.” in South Australia was - Australian Energy Market Commission increased by a series 2013 of circumstances, and these companies used the opportunity to maximise their financial returns. CHAPTER 03 6 THE ANATOMY OF A PRICE SPIKE
Competition concerns have long been expressed about South Australia’s highly concentrated market for gas power generation.
In response to competition concerns, Power plant closures or regulators have kept a watching brief on “mothballing” further increased the South Australia’s situation, specifically gentailers market power relying on the growth of wind energy and upgrades to the Heywood Interconnector (the The market power (and ability to set high high voltage electricity line enabling South prices) of South Australia’s gentailers has Australia to import and export electricity increased in recent times as electricity supply from Victoria) to dampen the market power and demand in the state have come closer of these gentailers (Australian Energy Market together. This has occurred due to excess Commission 2013). power generation capacity either being shut down (as in the case of Alinta’s Northern Already expensive gas power prices (Figure 2) and Playford coal-fired power due to export links plants) or “mothballed” and taken out of service for a period (such as Engie’s Pelican Unlike Victoria, New South Wales and Point gas-fired power plant). Queensland, which rely largely on coal for electricity generation, South Australia has historically relied mainly on gas for its power. Australian gas prices have increased and become more volatile since becoming linked to international Liquefied Natural Gas (LNG) markets (Melbourne Energy Institute 2016). The international export market for gas has also increased demand. High international LNG prices have led to some companies selling gas supplies overseas rather than using the gas for local power generation. This has led to the mothballing of gas power plants such as Pelican Point in South Australia and Swanbank E gas plant in Queensland (RenewEconomy 2016a). Figure 2: Northern coal-fired power station (now closed).
Heywood Interconnector removed to its maximum demand. This means that during peak winter demand competition to supply electricity in South Australia is even further limited. When the interconnectors (Heywood, and a smaller line called Murraylink) between Australia’s Electricity Market Operator South Australia and Victoria are operating, (AEMO) regularly predicts periods of high there is still more than enough interstate and low electricity demand (shown by the and local electricity supply to meet South wiggly white line in Figure 3). AEMO (2015) Australia’s electricity needs (with electricity forecast in October 2015 that these tight supply capacity almost double peak demand) supply-demand conditions would occur (AEMO 2015). in July 2016 (Figure 3) and the following summer, stating: However, in July this year, the Heywood Interconnector was taken out of service “After Northern Power Station is for up to two weeks to expand capacity, withdrawn, there are times when and further generating capacity removal maximum daily demand is projected occurred at a time of forecast winter peak to exceed supply from scheduled demand for electricity. generation in South Australia. At these times, the region will rely on imports (via With the Heywood interconnector out interconnection) and wind generation to of service and with Pelican Point fully meet operational demand” mothballed, South Australia’s power supply - AEMO 2015 (excluding wind and diesel) comes very close CHAPTER 03 8 THE ANATOMY OF A PRICE SPIKE
Removing the Heywood Interconnector for upgrade works during peak winter demand, was a recipe for disastrous price outcomes.
Figure 3: AEMO South Australia electricity supply and demand - shows Heywood Interconnector outage timed for SA Winter Peak. Source: Adapted from AEMO 2015.