The Catch 22 of Australia’s Future Electricity Pricing

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Most of the electricity debate in recent times has been about security of supply; will the power be available when you want to switch on your air conditioning during a 40 degree day this summer, and subsequent summers? While it’s a good conversation to have, a better one would be about price. More so, what you might be expected to pay for the privilege of being able to use power at those peak times.

Today, electricity pricing (whether it be wholesale or retail) is driven by what is expected to happen in the electricity spot market. Traditionally, prices have been low overnight (when demand is low) and when baseload power stations have had to reduce output. Prices are higher during peak times, but not excessively as the number and size of the baseload generators were planned around meeting the peak demands.

But everything is about to change.

What’s now happening in the generation mix will have a significant impact on the spot pricing. This has already occurred in South Australia with wind generation making up such a large proportion of total generation. At times when it is windy spot prices have frequently gone to zero, or even negative, while at times of low wind generation prices have gone very high. This price volatility has impacted through to retail prices.

According to AEMO in its recently released Electricity Statement of Opportunities there are 21,721 MW of connection requests in train in the NEM, comprising 10,678 MW large scale wind and 11,043 MW for large scale solar. To put this in to perspective, there is currently just over 47,000 MW total installed capacity in the NEM. While not all this new generation is likely to be built, a significant amount will be and for solar in particular, it will be at a speed too difficult for the system to adjust to.

The pattern of solar generation is highly predictable with peak output occurring in the middle of the day on sunny days and with output declining on either side of midday. Queensland is at the forefront of new large scale solar projects already being built as well as having the highest penetration of roof-top solar. The level of solar generation currently being built in Queensland on top of minimum running from existing coal fired generators is likely to result in their being an over-supply of generation in the middle of the day (on a sunny day). At that time pricing will fall to zero or below as these generators price to ensure that they continue to be dispatched.

With the amount of solar currently being planned in other states this impact is likely to be replicated elsewhere.

This may sound great for consumers, however what will the coal fired power stations do to ensure that they still make money? They will either increase prices at other times (ie when the sun isn’t shining), or ultimately close if it’s no longer economical to keep operating – pushing up prices and making it more likely that demand will not be met.

But high prices should bring other options into the market shouldn’t they? They should, but these won’t be as cheap as what we are used to paying for. Solar generators will invest in batteries, but will seek to recover this investment by charging for it during peak periods. Similarly pumped storage and quick start gas generation are capital intensive and the owners need to recover their costs from relatively short running periods. And demand response? How much will consumers expect to be paid to switch off their demand? I can guarantee you it won’t come cheap.

So we foresee a time in the not too distant future where prices are around zero or negative in the middle of the day, going to very high pricing, potentially $500/MWh (50c/kWh) or more during the morning and evening peaks, and staying much higher than we traditionally have known overnight.

You may say that in a rational market this sort of result shouldn’t eventuate – solar farms would not be developed if pricing was expected to be zero and baseload generators would stay if they expected to get high peak prices. And you would be right. However we do not believe that participants are currently behaving very rationally. New renewable generation is being developed by people with little experience in the Australian energy industry. They are jumping onto a surge of optimism based around the decrease in costs for solar and a willingness for people to invest in or contract for renewable generation. And once these have been built, they have to generate. The marginal cost of running once built is zero, irrespective of what it cost to build them.

As an aside, we are not anti-renewables, or coal. We are not advocating pulling away from the market which has worked so well for consumers for many years, nor for Government intervention (apart from the need to set consistent and clear long term policy). However markets only work well when participants are well informed and at the moment in our view this is not the case in many areas – from investors through to end users.

So what does this mean for end users? Retailers develop their pricing based on what they see in current and future spot pricing. Pricing volatility generally means increased risks and therefore increased margins to cover for that risk. If you use more power in the middle of the day then you are likely to be paying less for it. If you use more in the peaks or overnight then you will likely pay more. This also includes residential users who, unless they can shift their load to the middle of the day, would end up paying more (unless they are somehow subsidised by regulators).

And don’t think that investing yourselves in these solar projects will save you. As already discussed you will effectively be “protecting” yourself when prices are already low, and you will have no protection when prices are high. Unless you undertake your own additional investment and install batteries yourself to cover you for when the sun is not shining.

Specifically for larger customers who may have offers in front of them for Power Purchase Agreements (PPA) from prospective solar generators at $50-70/MWh for 10 plus years. These look great in the current electricity market. Do they look so good if the spot prices in the future drop to close to zero in the middle of the day? Ask yourself why the solar generators are looking at contracts direct from users when Retailers would make more logical partners. Or maybe they have tried to deal directly with Retailers already, and those Retailers were not prepared to pay what the generators were asking.