The rules of Australia’s energy markets continue to be redrawn after the South Australian pricing regulator on Tuesday cut its calculation of wholesale energy costs and recommended that retail electricity prices be cut by 8.1 per cent.
The draft decision by the Energy Services Commission of South Australia (ESCOSA) may only directly impact the customers of AGL Energy on standing contracts in that state – but it’s likely to have a profound ripple effect on the energy industry in Australia.
The decision recognises that the game is changing because of the growing impact of renewables and falling demand. It also recognises that the industry’s power over the regulators is waning fast, and its ability to gold plate its assets – be they networks or generation plant – is rapidly declining.
ESCOSA – against the wishes of the conventional energy industry – has redrawn the way that prices should be estimated. It was a bit of a no-brainer, because ESCOSA had previously allowed the wholesale price allowance to reflect what the utilities estimated as the long run marginal cost of energy. But it turned out that this calculation was up to three times the actual cost – ESCOSA had allowed electricity companies to pass on a rate of $90 per MWh, although the cost of the electricity on the open market had dropped to as low as $30 per MWh.
ESCOSA now proposes a calculation that better reflects the cost of purchasing energy on the wholesale market, and all the hedging that takes place as well. The result is that – even after taking into account the carbon price and the cost of renewable energy schemes – the wholesale component of the electricity bill will come down sharply – and translate into a cut in retail bills. It suggests that these cost reductions be reflected in the bills of all customers, not just those on standing charges.
This ruling should not come as a surprise, except to those who insist that wind and solar does nothing but add to the cost of electricity. For much of the past year, wholesale electricity prices have been trading at or around their lowest levels since the creation of the National Electricity market more than a decade ago, yet retail electricity bills have soared, thanks to billions of dollars in network spending which is now being heavily scrutinized.
But apart from a few instances, such as IPART’s decision in NSW where wholesale costs had a minor depressing effect in its recommended retail electricity estimations – consumers have not benefited from this fall.
South Australia, however, is a special case because the actual cost of buying electricity on the wholesale market has been impacted more directly by the “merit order effect” – the downward pressure on wholesale prices caused when wind and solar farms (which have zero cost fuels) are constructed and produce energy.
South Australia has the highest penetration of wind in Australia – it accounted for around 26 per cent of energy supply in the year to the end of July, overtaking coal and trailing only gas. It also has the highest penetration of solar PV in the country – 2.4 per cent of its electricity last year was sourced from rooftop panels – and this has made a major contribution to reduced demand on the NEM, and in turn to lower electricity costs. Indeed, AEMO has cut its energy demand forecasts for the state by 10 per cent, mostly due to a 7 per cent reduction from the solar-powered residential sector, where one in 5 houses has a rooftop solar installation.
The influence of wind and solar is expected to increase in coming years. AEMO predicts that solar PV will make up 3.4 per cent of energy demand in the state in the current year – rivaling the penetration in Germany, which has had a dramatic impact on wholesale prices. By 2020, it says, the solar PV could account for 6.4 per cent of demand. It estimates that one third of solar PV installed in the state is producing at times of peak demand.
This, in turn, has led to the state’s two coal-fired generators, to be put in mothballs because the ageing plants can no longer make money with wholesale prices falling so low. The two plants that once provided 30 per cent of the state’s energy have now been shunted out of the market by a combination of wind and solar – apparently more expensive – and lower demand. This is the future faced by the conventional energy industry everywhere – in the eastern states, in the US and in Europe.
This table below explains what happened in South Australia. In 2010, ESCOSA allowed a wholesale price component of $93.93, plus estimates from line losses, various fees and the cost of the the two components of the renewable energy target (large scale – essentially wind – and small scale – essentially rooftop solar).
The second column shows the increase when the impact of the carbon price is added in. But the third column reflects the new estimates, based on a formula the reflects the cost of buying energy on the market (not simply the spot price, because utilities need to hedge and lock in long term contracts), with an additional $8/MWh of “headroom” – a profit margin that retailers can play with to “compete” with each other, plus line losses and (slightly lower) estimates of the cost of the RET.
Note: The REC Agents Association underlined the impact of solar PV on wholesale prices in a research note that also points out that estimates of the impact of the cost of the small scale component of the renewable energy target have been grossly over-estimated, particularly by those seeking to have the target reshaped.
The RAA says the combination of rooftop solar and solar hot water has caused a 1.2 per cent fall in power consumption across the NEM – around half of the reduction noted in the market. It estimates this can be quantified at $20 per MWh, or 2 cents per kWh, and the contribution of rooftop solar to reducing power consumption is expected to more than double by 2015 – with further impact on wholesale electricity prices.
And it notes, the cost of the small scale scheme will continue to fall. From 2014, once the multiplier is phased out, it will account for less than one per cent of retail electricity prices. It also notes that the real cost of the scheme is well below the $40 a certificate that retailers are allowed to pass throught to their customers. The market price of these certificates is close to $30.
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