STATE OF THE ENERGY MARKET 2007 AUSTRALIAN ENERGY REGULATOR STATE OF THE ENERGY MARKET 2007 AUSTRALIAN ENERGY REGULATOR ISBN 1 921227 86 9 © Commonwealth of Australia 2007 This work is copyright. Apart from any use permitted by the Copyright Act 1968, no part may be reproduced without permission of the Australian Competition and Consumer Commission. Requests and inquiries concerning reproduction and rights should be addressed to the Director of Publishing, Australian Competition and Consumer Commission, GPO Box 3131, Canberra ACT 2601. ACKNOWLEDGEMENTS This report was prepared by the Australian Energy Regulator. The AER gratefully acknowledges the following corporations and government agencies that have contributed to this report: Australian Bureau of Agricultural and Resource Economics; Australian Financial Markets Association; d- cyphaTrade; Economic Regulation Authority of Western Australia; Essential Services Commission of Victoria; Essential Services Commission of South Australia; First Data Utilities Geoscience Australia; Independent Competition and Regulatory Commission; Independent Pricing and Regulatory Tribunal of New South Wales; Department of Industry and Resources, Western Australia; Offi ce of the Tasmanian Energy Regulator; Queensland Competition Authority; National Electricity Market Management Company; Northern Territory Treasury; and Utilities Commission of the Northern Territory. Contact Australian Energy Regulator Level 42, The Tower 360 Elizabeth Street Melbourne Central Melbourne VIC 3000 Postal address GPO Box 520 Melbourne VIC 3001 Tel: (03) 9290 1444 Fax: (03) 9663 3699 Email: [email protected] Website: www.aer.gov.au Design: True Characters, Melbourne Printing: RA Printing, Melbourne Cover printed on Raleigh Options Recycled PC 100, 352gsm Internal pages printed on Raleigh Options Recycled PC 100, 118gsm Options Recycled PC 100 is manufactured with non-polluting Green Power electricity generated from wind power, it contains 100% post consumer waste. Cover images: Fairfax Images CONTENTS vi Preface viii EXECUTIVE OVERVIEW 12 Report structure 15 Abbreviations 18 PART ONE — ESSAYS: FOCAL ISSUES IN ENERGY MARKETS 18 ESSAY A: STOCKTAKE OF ENERGY REFORM 36 ESSAY B: RELIABILITY IN THE NATIONAL ELECTRICITY MARKET 54 PART TWO — ELECTRICITY 58 CHAPTER 1: ELECTRICITY GENERATION 60 1.1 Electricity generation 63 1.2 Generation in the NEM 71 1.3 Investment in generation infrastructure 78 CHAPTER 2: ELECTRICITY WHOLESALE MARKET 80 2.1 Features of the National Electricity Market 83 2.2 How the National Electricity Market works 85 2.3 National Electricity Market demand and capacity 86 2.4 Trade between the regions 90 2.5 National Electricity Market prices 92 2.6 Price volatility iii 96 CHAPTER 3: ELECTRICITY FINANCIAL MARKETS 99 3.1 Fınancial market structure 101 3.2 Fınancial market instruments 103 3.3 Fınancial market liquidity 104 3.4 Trading volumes in Australia’s electricity derivative market 110 3.5 Price transparency and bid-ask spread 110 3.6 Vertical integration 111 3.7 Price outcomes 114 3.8 Price risk management—other mechanisms 116 CHAPTER 4: ELECTRICITY TRANSMISSION 118 4.1 Role of transmission networks 119 4.2 Australia’s transmission network 125 4.3 Regulation of transmission services 127 4.4 Transmission investment 131 4.5 Operating and maintenance expenditure 132 4.6 Reliability of transmission networks 135 4.7 Transmission congestion 140 CHAPTER 5: ELECTRICITY DISTRIBUTION 143 5.1 Role of distribution networks 143 5.2 Australia’s distribution networks 149 5.3 Economic regulation of distribution services 153 5.4 Distribution investment 155 5.5 Operating and maintenance expenditure 155 5.6 Service quality and reliability 168 CHAPTER 6: ELECTRICITY RETAIL MARKETS 171 6.1 The retail sector 178 6.2 Retail competition 189 6.3 Retail price outcomes 192 6.4 Quality of retail service 198 6.5 Regulatory arrangements 202 CHAPTER 7: BEYOND THE NATIONAL ELECTRICITY MARKET 204 7.1 Western Australia 213 7.2 The Northern Territory iv STATE OF THE ENERGY MARKET CONTENTS 214 PART THREE — NATURAL GAS 218 CHAPTER 8: GAS EXPLORATION, PRODUCTION, WHOLESALING AND TRADE 221 8.1 The role and signifi cance of the gas exploration and production sector 223 8.2 Australia’s natural gas reserves 227 8.3 Exploration and development in Australia 230 8.4 Gas production and consumption 234 8.5 Gas prices 236 8.6 Industry structure 243 8.7 Gas wholesale operations and trade 249 8.8 Gas market development 252 CHAPTER 9: GAS TRANSMISSION 254 9.1 The role of the gas transmission pipeline sector 255 9.2 Australia’s gas transmission pipelines 257 9.3 Ownership of transmission pipelines 259 9.4 Economic regulation of gas transmission services 265 9.5 Investment 270 CHAPTER 10: GAS DISTRIBUTION 272 10.1 Role of distribution networks 272 10.2 Australia’s distribution networks 275 10.3 Ownership of distribution networks 276 10.4 Regulated distribution networks 279 10.5 Investment 280 10.6 Quality of service 284 CHAPTER 11: GAS RETAIL MARKETS 286 11.1 Role of the retail sector 287 11.2 Gas retailers 292 11.3 Retail competition 299 11.4 Retail price outcomes 302 11.5 Quality of service 303 11.6 Regulatory arrangements 307 PART FOUR — APPENDIXES 308 APPENDIX A: INSTITUTIONAL ARRANGEMENTS 313 APPENDIX B: GREENHOUSE GAS EMISSIONS POLICY 318 APPENDIX C: AUSTRALIAN TRANSMISSION PIPELINES v PREFACE Th e Australian Energy Regulator (AER) is Australia’s With the rapid evolution and growing complexity independent national energy market regulator. of energy markets, the AER believes there is a need It monitors and enforces compliance with the national for reliable and accessible data to assist stakeholders. legislation governing the electricity and natural gas Th e State of the energy market report consolidates industries and is the economic regulator of the electricity publicly available information from various sources into transmission sector in eastern and southern Australia. a single user-friendly publication. At present, energy Its regulatory responsibilities will soon extend to gas market data is published by various bodies, including transmission, energy distribution and non-price aspects the AER, state regulators, market management bodies of energy retail markets. Th e AER also assists the (such as the National Electricity Market Management Australian Competition and Consumer Commission Company), the Energy Supply Association of Australia, on energy competition matters such as merger issues d-cyphaTrade, EnergyQuest, the Australian Fınancial and energy authorisations. Markets Association, government agencies such as ABARE and the ABS, private monitoring bodies and In undertaking its work program and in preparing for others. While each publishes high-quality data, the the transfer of new functions the AER monitors and focus is naturally on the specifi c areas of responsibility collects a range of information on the energy sector. or interest of each body. Conversely, there is little Th e AER has decided to publish this information public data available on some aspects of market activity. periodically to improve market transparency. Th e State Th ese conditions can make it diffi cult for an observer of the energy market report is the result of that decision. to discern a global sense of what is happening in energy Th is report aims to present a big picture perspective on markets. Th is poses challenges for market participants energy market activity in Australia. It has been written and can aff ect the quality of the policy debate on energy for a wide audience, including government, industry market issues. and the broader community, and supplements the more technical weekly and quarterly reports the AER already publishes on activity in the National Electricity Market. vi STATE OF THE ENERGY MARKET PREFACE It should be noted, however, that the AER is not a policy Th e 2007 survey of market activity and performance body but a regulatory agency. In that context, the State covers each segment of the electricity and gas supply of the energy market report focuses on the presentation chain in turn—from electricity generation and gas of facts and is not a vehicle to advocate policy agendas. production through to energy retailing. Th ere is also While some policy areas are noted in the report, they are a survey of contract market activity in electricity presented for information purposes only. derivatives. While the report focuses on activity in the southern and eastern jurisdictions in which the AER Th is State of the energy market report focuses on the has regulatory and compliance roles, there is also some AER’s current and future areas of responsibility, but coverage of market activity in Western Australia and the for completeness covers most aspects of the energy Northern Territory. sector, including comparisons with international energy markets. Th is is necessary to document the increasingly Th is is an evolving project. As a fi rst report, this edition complex relationships between market segments and sets the scene with background material on the structure the policy environment within which they operate. and design of energy markets. Future editions will adopt For example, there are increasing ownership linkages a more succinct approach. Th ere may also be changes between the electricity generation and retail sectors that in approach over time to particular areas of reporting. make it diffi cult to analyse market behaviour in either For example, while the 2007 edition includes separate sector in isolation. Similarly, the electricity derivatives chapters on electricity and gas retailing, future editions market is now an integral adjunct to the spot market. may consider a more integrated approach to energy retailing in line with the evolution of that sector. In Th e AER envisages that each edition of the State of addition, there are areas of market activity where the the energy market report will consist of a survey of quality of public data is uneven. For example, there is market activity and performance in electricity and gas limited data on gas wholesale prices, energy retail prices supported by focal essays that develop particular issues and market shares in the energy retail sector.