Australia relies on politicians to set long-term energy policies that facilitate a flexible, reliable and low-emissions energy system.
For renewable energy developers, one of the most important (and obvious) risks is policy uncertainty.
Policy malaise in the sector — including the failure to achieve a sustainable carbon pricing mechanism, a freeze on renewables and arbitrary restrictions on gas supply — has contributed to higher wholesale prices in both the electricity and gas markets by delaying new investment.
Unfortunately, we are now seeing a backlash from the political class — reflecting the collective opinion of the Australian public that cares little for underlying causes — against the market outcomes that the political class itself contributed to.
Premiers and senior Ministers in two of the six states in the National Electricity Market are now actively campaigning against market outcomes.
So the NEM’s working just fine is it? pic.twitter.com/6Ek1xauF9q
— Tom Koutsantonis (@TKoutsantonisMP) February 7, 2018
Tasmania is the smallest state in the NEM, which it joined in 2005. However, poor policy could have national consequences, so it is worth looking at the Tasmanian situation and the State Government’s election campaign announcement that it is “exiting the NEM”.
Hydro Tasmania is State-owned and operates a hydro-electric system that has capacity totalling 2,500 MW. This system is constrained by energy — water in storages — rather than capacity.
Physical connection via Basslink was completed in 2006. Basslink is a merchant rather than regulated interconnector, and its owners exchanged the variable cash flows arising from interregional price differences for a largely fixed facility fee paid by Hydro Tasmania under a long-term contract expiring in 2031.
Tasmania has three major wind farms with combined capacity of 308 MW. In the private sector, another three large-scale wind projects are at an advanced stage, a huge wind farm is proposed for the north-west that could add 1,000 MW and have its own transmission connection into Victoria, and several smaller wind and solar projects are in the development pipeline.
Hydro Tasmania has a suite of projects known as the “Battery of the Nation” and TasNetworks has commenced a formal study on a second interconnector.
The gas-fired Tamar Valley Power Station has one of the most efficient combined cycle turbines in Australia as well as peaking units.
These provide market-based opportunities and thermal drought support, which was proven during the 2015-16 energy crisis after an unexpected 6 month Basslink outage compounded low inflows.
A market-based price is essential for this complex system to work effectively, to progress the proposed projects, and provide a return to the Tasmanian public for their investment in Hydro Tasmania and Aurora Energy (the incumbent retailer).
From the time that Basslink was conceived, a foundation principle was that the Tasmanian price would follow the Victorian price.
For a decade, NEM prices were generally below the cost of new entry, which would generally cap wholesale prices in an efficient market. Accordingly, many Tasmanian consumers benefited from low wholesale prices under this principle.
An added complication in the market structure is that Hydro Tasmania could exert market power under certain conditions.
A competitive wholesale market has proven elusive, particularly after the failure of Babcock & Brown during the GFC led the State to buy the partly-built Tamar Valley Power Station and complete its construction. In the words of the Tasmanian Economic Regulator:
“in no other NEM jurisdiction is a single company responsible for such a significant proportion of all generation output within the region, with control of interconnector (Basslink) flows, and is the dominant counterparty for wholesale contracts.”
To formalise the pricing nexus, increase transparency in the wholesale market, mitigate this market power, and facilitate the sale of Aurora Energy’s customer book (later aborted), a new regulatory instrument from 2014 effectively capped the price for standard wholesale contracts with a rules-based link to the Victorian forward curve.
These regulated prices are available to all retailers and provide a signal to current and prospective market participants.
As the supply-demand balance tightened with the threatened (later confirmed) closure of Hazelwood from late 2016 — which exacerbated the public’s existing sensitivity to the cost of power given increased network charges — it was inevitable that Tasmanian prices would rise in line with Victoria’s.
Unfortunately, as the public’s confidence in the NEM breaks down — and our political leaders fail to support the market that five states and the ACT created — important microeconomic principles are being discarded.
This distaste for higher prices, and an untested economic development argument, underpin the Tasmanian Government’s election campaign announcement that it is “exiting the NEM” by 2021.
Despite the attention-grabbing (and confusing) headline, the Government actually intends to delink the wholesale pricing mechanism from the Victorian price.
This policy pre-empts a State Treasury review and targets a reduction of around 20 per cent compared to current wholesale contract prices.
The Government would also preserve the spot market to enable “selling at higher prices into the NEM”, notwithstanding the likely need for complex inter-regional hedging arrangements to secure these prices.
The specific mechanics of a new instrument are unknown. Like other well-meaning interventions, adverse consequences could easily result, such as:
- jeopardising new investment, particularly in uncommitted projects;
- undermining growth in embedded solar PV systems, and associated storage;
- exacerbating perceptions about Hydro Tasmania’s market power if it leads to lower levels of wholesale contracting; and
- further delaying — perhaps forever — the development of effective competition in the retail market.
The policy also has a sustained and significant cost to the State budget, at a time of rising long-term challenges for the State budget including threats to the State’s share of GST revenue, health and education funding needs, and an unfunded superannuation liability that peaks in 2031-32 with a cash cost exceeding $400 million.
At a time when political leadership is required, the NEM and the Tasmanian community would be best served by political support for the market and the principle of market-based wholesale prices, linked to Victoria, rather than a government intervention that could have significant adverse consequences.
Phil Bayley is a Director at Climate Capital — a developer and advisor specialising in renewable energy generation — and is experienced in commercial strategy, financing and market development in the energy sector. He worked for 10 years in Tasmanian Treasury, overseeing State-owned electricity businesses and several aspects of economic regulation, and is a former Chief Economist at the Tasmanian Chamber of Commerce and Industry.
