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Which fuel is setting electricity prices? Clue: it’s not wind or solar

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Which fuel is setting the price of electricity in Australia? It seems pretty obvious, from all the official reports and anecdotal evidence that it is gas. And because the price of gas has more than doubled in recent years, that means that the price of wholesale electricity has also doubled over the same period.

It is one of the quirks of the wholesale pricing system that the price is set by the last generator into the market, and that is always the most expensive. And it is not just that generator that enjoys that price – all the generators benefit.

Imagine going into a supermarket and buying five apples for 50c each, and then deciding you want to buy one more. The vendor says that the price of the sixth apple is $10. And you have to pay a total of $60 for all six apples if you want it. That’s kind of how the electricity market works.

(And in the electricity market the vendors often hide the apples in the back room to give the impression of scarcity).

But here’s a curious thing. It was not so long ago, just two years ago, that most of the pricing in the wholesale market was set by hydro plants, which can easily be turned on or off.

This graph below – from the gas statement of opportunities report prepared by the Australian Energy Market Operator – shows the preponderance of price setting by hydro (which is supposed to be cheap but often is reserved for peaking generation) in 2014/15.

For some reason, just one year later, in 2015/2016, the hydro plants all but disappeared from the price setting, and only made an appearance in most states at the very highest prices, which used to be set by gas.

marginal price setting

What’s going on?

Analyst David Leitch had a go at highlighting the issue with his analysis of the Wivenhoe pumped hydro storage facility in Queensland – the bit little pumped hydro that didn’t – noting that it was rarely used by its owners, who seem to favour gas, and only switched on when really high prices could be obtained.

Dylan McConnell from the Climate and Energy Institute in Melbourne notes: “That gas is setting the prices more often and at high price makes sense,” given that the price of gas has jumped. “It’s less clear why hydro would be setting the price at a high level.”

Basically, it all comes down to those apples, and the ability of those vendors to control the market. They have no ability to do that when there is plenty of wind and solar energy being generated, but when the wind don’t blow and the sun don’t shine, they can charge what they want for gas and hydro, and (mostly) get away with blaming it on renewables.

   

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  • Ren Stimpy

    A classic conflict of interest and a classic Australian government way of fucking the market for the benefit of their scrounging/lounging Liberal mates. Shame on Turnbull for prolonging this abysmal situation. The guy is smart enough to know this but he won’t ever do anything about it.

  • Joe

    “Energy Market”…everything is a market these days. Of course where a profit is to be had then us mug punters will be… collateral damage. “Energy Service” is what we all want and delivered to us at a fair price. How good is the form of Big Mal these last weeks. I mean it was “Clean Coal and New High Efficiency Coal Power Plants” not long ago. Next it was “Snowy Hydro 2.0″…feasibility study only. Next it was all about Gas, as base load power and sorting the impending “Gas Crisis”. Next it was “Tassie Hydro 2.0″….feasibility study only…AGAIN. Now we apparently do have the full monty “Gas Crisis” and Big Mal has got the solution with his strongman intervention. Ya just gotta luv Big Mal, he is everywhere but really he is nowhere. Electricity retail prices are set to rocket with new usage charging rates from July. I can’t think of a better advertisement for household solar and battery storage. The electricity retailers may have kicked a giant OWN GOAL this time. No sympathy from me though as I’ve got my solar rooftop and adding home battery storage, it is looking more and more delicious every day.

    • Ken Fabian

      It’s own goals all the way – although it may not be immediately apparent. This decision is done on the run by people who lack foresight and refuse expert advice they don’t like. The decisions made this year won’t last past next year and will be irrelevant in the face of the very market forces they claim, but only when it suits them, to hold in esteem; gas isn’t likely to drop greatly in price from these measures. It’s a defacto carbon price that will ultimately boost investment in renewables.

      It’s a great shame that they can’t bring themselves to use the emergent market mechanisms that favour renewable energy intelligently, embracing The Transition instead of working to derail it. The window of opportunity climate science has given us to avoid the very worst is getting smaller. Whilst the end of the road for the course that embraces The Transition may be fogged with uncertainties, the end of the road for the course that rejects the transition looks stark and clear and expensive in comparison.

  • Steve Phillips

    The marginal cost of production for hydro is very low, but for gas it is very high, hence the gas producers bid in at high prices reflecting the cost of gas. The hydro generators have a limited water resource, so I’m thinking that when they have plenty of water to spare, and there are imminent predicted in-flows, they may as well bid in low since the water they use will be rapidly replaced. Conversely, when their reservoir levels are running low, with no prospect of imminent in-flows, they would bid in high, so hydro could well be setting the price at times of low reservoirs and low in-flow. I’m sure they have a team of analysts doing lots of in-flow forecasting and optimising this against forecast grid prices to try and maximise their profits… that’s exactly what I would do.

    Gas would be different since gas generators would bid in at the marginal price for burning the gas, which would be pretty constant all year round, assuming no large changes in the gas price. Hence one would expect gas to be more often a price setter than hydro.

    • deadgodstalking

      Yes that’s right – the NZ electricity industry is hydro-dominated and the companies there explain their strategies in this way.

  • Tom

    There’s two kinds of hydro releases, discretionary and irrigation. In FY15 hydro is trying to get the most out of a flat price distribution by bidding a bit above coal.
    In FY16 you can see the irrigation releases further down the curve as well as discretionary at the top. In NSW particularly Snowy is bidding at $299 to covers caps so you get a little flat bit. There’s just not enough water for hydro to set price as frequently as in the past. Capacity factors for hydro are in the low teens.
    Also of interest is how hydro and black coal used to set price so frequently even in states without hydro (SA) or black coal (SA, VIC). The NSW market is so massive compared to the other states and NSW black coal is higher cost than VIC/QLD so they would often set price NEM wide. This meant that often wind in SA was displacing coal in NSW.

    • Jonathan Prendergast

      Very interesting insights. Thank you.

    • Bob_Wallace

      If dams are running short on water might it not make sense to add a lower small lower reservoir and make them dual purpose hydro and pump-up hydro?

      • Tom

        Yep. The govt. is doing a feasibility study on converting to pumped hydro for the Snowy and Tasmanian hydro schemes. Something like 4-5 GW of potential capacity. It’ll need some serious transmission upgrades, although that will open up a lot more interstate trade which is useful even when the hydro isn’t in use.

        • Bob_Wallace

          Thanks, Tom. So let me dig a bit deeper so I better understand what is happening…

          I know nothing about “Snowy and Tasmanian”. Looking at Wiki Snowy is a collection of 16 dams, some of which seem to be electricity producers. Tasmanian has 30 dams.

          Now, running short of water. Has there been a significant, long term change in precipitation in those areas? Or is there another reason for running short?

          So the plan would be to upgrade the power systems by adding more turbines (and pumps) to the currently producing dams, possibly the dams which are not now producing, and convert them to pump-up storage?

          • Tom

            Hi Bob,
            The Tasmanian dams are built to supply the typical Tasmanian demand over a year, smoothing out wet and dry years. Their connection to the mainland (more recently built) allows for some increase in the value of their water. The plan to expand would allow for increased Tasmanian wind farms (extra energy currently not needed) and pumped storage by purchasing from the mainland.
            Snowy is an irrigation scheme with several high head power plant and low head water flow dams. They already have some pumping ability but there was historically not enough price difference to pump regularly. Expansion would require better connection to Sydney and Melbourne and a new turbine and pipes between existing dams.
            The benefit of the upgrade idea is that most of the cost has already been laid out for dam walls. The downside is the extra expense needed for transmission.
            In terms of water there’s no large change in rainfall, Snowy in particular was simply built as a peaking plant. They are making a lot of their money from selling insurance against prices above $300, hence the bids at $299.

          • Bob_Wallace

            Thanks again, Tom.

            Any estimates for how much it costs to convert an existing dams to pump-up? Cost per MW. Not including transmission since that will vary by distance to be covered from dam to dam.

            In the US we probably have over 7,000 PuHS conversion dam candidates. 10% of about 80,000 existing dams.

          • Tom

            Hi Bob,
            The turbine alone should be about $0.3/W if I recall correctly.
            Extra piping and civil work means that the govt. estimates are for ~$1/W.
            Usually you would expect either civil work for one of the reservoirs or a new pipe.

  • Just_Chris

    I suspect that the price is being pushed up by a few companies not a few fuel types. I am sure those who trade on the NEM know exactly what drives the price up or down. It’s then just a matter of taking control of the leavers. My feeling is we’ll “fix” the gas market only to find problems with the black coal generators or the inverter based technologies (wind, pv and batteries). I’m yet to see someone suggest a cure to the problem rather than just treatment of the symptoms.

    • Jonathan Prendergast

      Is it any more complex than just investing in more supply (and reducing demand).

      We did not have this problem between 2011 and 2015 due to investment in Wind and rooftop solar, and reduction of demand. An oversupply at the time saw prices very low: both average pool prices and energy contract prices.

  • Jonathan Prendergast

    Watching the market casually and intermittently, it appears the only thing bringing down NEM pool prices each day is solar around midday?

  • deadgodstalking

    “… blaming it on renewables”… Hydro is renewables, you know – it just happens to be dispatchable! As and when solar and wind add highly-flexible storage with fast ramp rates to their projects, they will act similarly, deferring dispatch to maximise revenue, and potentially holding back supply at certain times if they think they can trade off some volume for price and earn greater returns. As will the Pt Augusta CSP plant if it gets up.

    • Calamity_Jean

      Well, that stinks. No wonder Australians want their own solar and batteries.

  • Gary Rowbottom

    I can’t get the picture out of my head of rooms full of energy market traders, all wannabe wolves of Wall Street, playing some demented type of “Roller Coaster Tycoon” game, but using real money, our money, in search of profits for their masters. I have to agree with Bruce Dinham, 5th of the 9 General Managers of ETSA, in questioning what real value is being added to the electricity supply system, to our nation, by this market system.

  • Mark Meyrick

    Plants with scarcity value will always game an energy market. In the UK, where we only have a few coal plants left in an increasingly renewables powergen set, make sure that they extract their pound of flesh when called upon – which is why our short-term markets are becoming increasingly volatile. The answer, ultimately, is storage – but in the interim, while we wait for battery technology to become cheaper and more widely deployed, all our markets are subject to this gaming /oligopolistic behaviour/ extracting scarcity value – call it what you will