Smart energy: How to profit from falling demand

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After decades of uninterrupted and more or less predictable growth, the Australian electricity industry is facing up to a daunting new reality: the business model that has been built around erecting more poles and wires and selling more electrons is coming to an end. Technology and changing economic conditions have altered the nature of the game.

Consider this graph below, published today by the Australian Energy Market Operator (AEMO) in its special update of its statement of opportunities, the annual estimate of future energy demand that is considered the bible for the energy industry. Only this time, the bible got it wrong. Badly wrong.  The yellow line marks the predicted growth in electricity use in the National Electricity Market out to 2020, the orange line reflects the reality of what has happened so far. A prediction of a 3 per cent rise for 2011 (made towards the end of the year) translated into a two per cent fall.

The most striking aspect of the graph is that the yellow line was only composed in August last year. The 5 per cent variation in forecasts has occurred in just seven months, and such has been the speed and impact of the change in circumstances, that the energy industry’s best predictions are now completely redundant, and will have to be recast.

So what suddenly changed? The AEMO update says a combination of factors have played a role in reducing demand well below predictions. These include the changing economic factors, such as lower global growth and the rising Australian dollar, which have reduced manufacturing capacity, and electricity demand, particularly in the aluminium sector.

The other key factors are the growing impact of rooftop solar PV and of energy efficiency. “It is becoming apparent that electricity consumers are changing their energy use in response to rising electricity prices and are adopting energy efficiency programs and the installation of rooftop solar photovoltaic systems,” it notes. And then there is the variable impact of milder weather.

Peak demand is also well below predictions. This is due almost entirely to the reduced number of extremely hot days in our summer. Mike Sandiford, the director of the Melbourne Energy Institute, estimates that the number of hours where demand in Victoria surged about 8 gigawatts fell from 159 hours in 2009 to just 25 hours in 2011.

This is having, and will continue to have, a significant impact on the business models of generators, who rely on these peak periods, when prices paid for all generators can surge to $10,000/MWh or more (compared to an average of $30-$40/MWh, for their profit margins. This impact – on profits and the ability to service debt – will only be heightened by the introduction of the carbon price in July.

It is estimated that around one quarter of the electricity sector’s revenues come from just 36 hours of peak production a year. As has often been cited as an example, the transport equivalent would be like building a 36-lane highway or Sydney Harbour Bridge to cope with maximum demand.

The impact on the electricity industry is already significant. Origin Energy CEO Grant King said in this fascinating interview with RenewEconomy last week that the fall in demand meant that no baseload energy would be required before 2020. He said the only opportunities for expansion will be in renewables (mandated by the 2020 target), and in peaking gas.

The AEMO report confirms that prognosis, and it also suggests that the need for extra peaking capacity may also be deferred. Sandiford suggests some of it could be deferred permanently, particularly with the roll-out of more distributed energy (small to medium-sized solar PV farms, for instance), and if stricter energy efficiency standards were introduced for domestic air conditioners. Changes to market rules that pave the way for more demand management, where some users are paid for NOT using power at peak times, will also reduce the need for more peak power.

“There are a range of things we could do to optimise the system for everyone’s benefit – and not just the network providers,” Sandiford says. “We don’t build our highways to accommodate peak flow. Why should we do that for the electricity grid and build new infrastructure  just to add to capacity.”

Indeed, a report last year by the Institute of Sustainable Futures found that one third of the $45 billion spend planned for the network in the current five-year period was not needed. The AEMO data would appear to reinforce the case. And until that occurs, the benefits of reduced demand and falling wholesale prices will not be passed through to consumers, because well more than half their bill comes from network costs.

As Sandiford pointed out in this piece for RenewEconomy last month, falling demand  and the weak prices will pose an enormous challenge to the energy industry. Demand for electricity traded on the NEM has been falling for three years and is now almost 10 per cent below predictions at the time.

That’s good news for those who are seeking a decoupling of GDP growth from energy intensity, but not for generators faced with a shrinking market and a wholesale spot market that is designed to create the minimum price possible. In Victoria, the average wholesale price was down 20 per cent from 2010 and less than half of 2007 prices, when a drought restricted coal and hydro generation and pushed up prices as more peaking plants were brought in to meet demand.

Sandiford says the AEMO data reinforces the need to rethink market incentives – to encourage and incentivise distributors to accommodate rooftop PV and to implement demand management.  

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  • Warwick

    An interesting article but a few points need to be noted.

    1) La nina – although electricity may be showing some elasticity of demand and the effects of pink batts, some PV and efficiency measures have some influence…the lack of a “normal” summer (2nd coldest in NSW) must not be overlooked.

    2) Generators contract to minimise electricity pool price risk. Who estimated that 1/4 of the electricity sector’s revenue was earned in 36 hours? Generators may earn 1/4 of the pool revenue in 36 hours in a given year but will hand almost all of those super-profits back to retailers within a few hours on a given settlement date because of financial contracts. This statement is misleading….like saying you have a windfall gain for the insurance payout you get when you write off your car.

    3) Market rules – “Changes to market rules that pave the way for more demand management, where some users are paid for NOT using power at peak times, will also reduce the need for more peak power.” What changes are proposed? The existing rules already allow for demand side management. Large customers have had demand side management contracts since before the market started such as interruptibility for smelters and homeowners have had air conditioning and electric hot water on ripple control for at least 2 decades. Further changes will require the installation of proper smart meters and political will.

    • ken

      I agree strongly with Warwick, it would be nice to think that the major drop in
      demand is due to energy efficiency measures and renewables but the drop in
      temperatures in Eastern Australia due to two strongly La Nina years is almost certainly the main factor. This has had a particularly big effect in Summer when extreme heat leads to much greater air conditioner use.

    • Jake

      Warwick, I read somewhere that spot-prices in the NEM are capped at $10k/Mwh, if the spot market ultimately doesn’t matter, since retailers can recoup the outlay through the use of forward contracts, then why did they bother with a cap?

      • Evcricket

        Hi Jake, spot prices are capped at $12,500/MWh. This is set by AEMO and is called the “MCAP” (market cap). It used to be VOLL (Value of lost load) and was capped at $10k/MWh

  • Mike Reeves

    Enjoyed the article re Smart Energy but I can’t see the graph on my browser. I looked it up but the document referred to is 323 pages long, and don’t have time to read it completely right now. What page is the graph on?

    • Giles Parkinson

      Hi Mike
      Not sure why you can’t see graph/ Which browser you using.

      The good news is the update is only 5 page long. So for you and others not seeing our graph, check it out on page 5 here …

      • Evcricket

        Ahahah, I didn’t get the graph at work either, so I sent a rude email to IT.

        Worked on my phone though.

  • Hi Giles,

    Like Mike, I have not been able to view the graph on my PC. I’m running explorer. I’ve just found that I can however view the graph on my iPad.

    Maybe it is a Jobs vs Gates thing . . .

    • Ron

      Google Chrome shows the graph!