A generator’s nightmare: low prices, less demand

Print Friendly, PDF & Email

Our grid is less productive, and the ratio of average to peak demand is declining. Time to rethink market incentives.

share
Print Friendly, PDF & Email

With the press coverage focused on retail price rises and the impact of the carbon tax, a breaking news story in the electricity game has slipped through to the keeper. Demand for electricity traded on the National Electricity Market – or the NEM – declined in 2011 for the 3rd consecutive year and is now down 3% since 2008.

With industry analysts predicting 2-3% annual growth rates over the period, demand is down almost 10% on expectations.

Partly we are seeing the impact of energy efficiency measures, such as pink batts, and distributed generation like rooftop photovoltaics. We are probably also seeing some price sensitivity entering the market.

While the good news is the decoupling of GDP growth from energy intensity, it is deeply worrying for our electricity generators. Not only is their market is shrinking, but also the structure of NEM – which runs a wholesale spot market – is causing their revenue to plummet.

Spot prices are sensitive to the proportion of surplus generating capacity. When surplus capacity is around 15% energy spot markets work well in balancing the needs of consumers in checking wholesale prices and in providing reliable supply, while also providing enough price incentive for generators to make new investment. On spot markets, too little surplus and prices rise, while too much surplus and prices fall.

Declining demand increases the surplus which, according to some estimates, is already well above optimum at around 25% on the NEM.

At an average of 5.7 gigawatts, 2011 demand in Victoria was down 2% from 2010 levels and almost 4% from 2008. Similar scenarios played out in NSW where demand is down some 2.7% since 2008, and Queensland where demand has softened by 3% since 2009.

And the value of electricity traded on the market is showing it. In Victoria, the 2011 wholesale price averaged 3.1 cents per kilowatt hour, down 20% from 2010, and less than half 2007 prices. Adjusted for inflation, Victorian 2011 wholesale prices were the equal lowest with 2003 since the NEM started in late 1998.

High wholesale prices of 2007 tell a story. Drought conditions constrained both coal and hydro generation across the NEM, effectively reducing surplus and allowing higher cost peaking-plants to set the wholesale price more of the time.

Weather is crucial in the electricity game. Demand peaks as temperatures soar in heat waves. On January 29, 2009, temperatures in Melbourne reached 43 degrees and demand peaked at over 10 gigawatts. The Basslink inter-connecter between Tasmania and Victoria failed, and the wholesale price hit $10000 a megawatt hour. The traded value of electricity on the Victorian market that day was around $530 million. At 20% of the market value for the year, it contributed more than 1 cent to the annual average wholesale price.

In 2011 wholesale prices remained low in part because declining demand effectively boosted surplus capacity, but also because a strong La Nina weather pattern resulted in cooler than expected temperatures, with few extreme heat events.

With 2011 wholesale prices down why are we experienced double-digit percentage rises in retail prices, already at around 20 cents per kilowatt hour?

For one thing, much of the generation is forward contracted so the wholesale market doesn’t actually dictate the price paid by retailers. In 2011 retailers undoubtedly paid more than the wholesale price, partly hedging against the potential of extreme heat events that didn’t occur.

But it’s the distribution, not generation, that accounts for the spiralling costs in our electricity bills.

While average demand is falling, peak demand continues at near record levels. So distributors are required to provide an infrastructure that carries fewer electrons on average, while capable of serving ever more electrons for the few hours of peak demand each year. The ratio of average to peak demand is falling steadily across the NEM from 73% in 2006 to 66% in 2011. In Victoria it has declined from 71% in 2004 to 60% in 2011.

In effect our grid is becoming less productive at the alarming rate of about 1 percent each year. It is putting huge pressures on the distributors, who have the additional problems of maintaining an ageing infrastructure as well as accommodating new demands such as the feed-in from domestic photovoltaic.

This declining ratio of average to peak demand is an elephant in the room as far as national productivity is concerned and it’s only likely to get worse.

With multiple pressures facing generators and distributors, and the added need to reduce the emission intensity of our electricity supply, it may well be time to rethink our market incentives.

For example, incentivizing distributors to accommodate rooftop photovoltaic and retailers to implement demand management, would seem a straightforward way to help shave peak loads and reverse the declining productivity of the grid. It’s likely to have to happen anyway when grid parity for rooftop photovoltaics arrives in a few years time.

These are challenging issues for the business of electricity, worrying for government, business and consumers alike. But in helping decouple GDP growth from energy intensity, they also provide a great opportunity if we can get our policy settings right – and then stick to them.

Prof Mike Sandiford is director, Melbourne Energy Institute, University of Melbourne.

 

Print Friendly, PDF & Email

6 Comments
  1. Warwick 7 years ago

    Unfortunately this article only tells part of the story and overlooks the impact of swap and futures contracts that exist between retailers and generators. It is true that if lower wholesale spot prices persist that generator pool revenues will fall. In the short to medium term, where both retailers and generators contract, if there is a fall in energy demand and spot price, then it is the retailers that will likely be worse off. This is because their customer revenue falls whilst they still need to make payments to generators on electricity that is not consumed. Generators will benefit having locked in their total revenues but will have reduced input costs through reduced fuel use. It is only if low spot prices persist and contract prices also fall that generators will be noticeably worse off.

    The effect of the January 29 day in Victoria is indeed more than 1c and that day actually contributes more than $6.40/MWh to the annual time-weighted price of $36.48/MWH in Victoria for 2009.

    • Jake 7 years ago

      Yes, but don’t they re-negotiate forward pricing contracts each year? If during the previous year’s ‘peak days’ they saw a significant amount of low margin generation underbidding conventional sources, wouldn’t they factor in its availability next year? Perhaps I don’t understand how the forward contracts work.

      • Matthew Wright 7 years ago

        Jake,

        You are correct, and if the financials don’t support contracted gas because the gas turbines will be used 85% less than before then they will disconnect from gas and setup kerosene tanks next to the plants and just run the shorter number of hours per year on trucked in kero.

        Once all the contracts wash out we’ll all be better off.

        Warwick seems to be a bit unclear on the fact that they all recontract after a few years.

        Matt

  2. Paul McArdle 7 years ago

    Thanks Mike,
    It does look to be a significant issue, if just looking at the 13 years of NEM history, as we did here:
    http://www.wattclarity.com.au/2011/09/how-is-demand-changing-in-the-nem/

    When looking over a longer (30-year) trend for QLD, perhaps it might be seen that the changes are more cyclic in nature:
    http://www.wattclarity.com.au/2011/11/a-30-year-historical-window/

    For those interested in more background, we’ve included further discussion here of possible reasons, based on those suggested by a range of people we spoke with about this:
    http://www.wattclarity.com.au/2011/10/some-possible-reasons-why-demand-is-declining/

    We’d agree that the business case for demand side response is growing, so this is something we’re actively working to support – and we’re seeing increasing numbers of large energy users provide this service to the NEM.

    Cheers

    Paul

  3. Warwick 7 years ago

    I think Paul has picked it correctly that there is a cyclical nature to load and generation growth. His observations about the reasons for demand growth slowing seem entirely sensible.

    I would suggest that people exercise caution about using low spot prices as a predictor that contract markets will soon fall in step with spot. As an example, in the late 90’s QLD was one of the more expensive NEM regions but new baseload power stations such as Milmerran and Callide C were built this century….Contract prices fell to below $30/MWh but were as high as $100/MWh in 2007 in response to drought and NSW generator bidding behaviour. If you go back as far as 1996-97, NEM1 (Vic and NSW only) had spot prices that sat at $11/MWh almost all the time…this relected the short run marginal cost of coal and that the vesting contracts negotiated between retailers and state goverments were at prices much closer to 4 times this amount.

    The people who work at generators are paid to be as profitable as possible so won’t contract too much generation at prices below their long-run average cost. They may withdraw capacity by temporarily mothballing plant such as Macquarie generation did when it publicly stated that it would only run 6 out of 8 of its generating units in the early 2000’s. Alternatively, they may also bid at much higher prices at times of high demand or withdraw supply at short notice to game prices…this has occurred numerous times such as AGL’s uncontracted Torrens Island power station that kept prices in the thousands in SA in previous hot summers. If you run less often with a higher fuel cost and a reduced contract position your bids will inevitably be higher…

    It would be brave to suggest that the current lower spot prices will persist indefinitely. A mild summer influenced by la nina and no very hot days is surely a factor. The article mentioned that 1 day was 20% of the value of energy in Victoria. In generation a “swallow does not make a summer” but a 40+ degree day on a weekday in one or more of Sydney, Melbourne or Brisbane with a generator off-line, bushfires or another drought would likely make high spot prices the news of the day.

    • Matthew Wright 7 years ago

      Hi Warwick,

      Thanks for your response. Unfortunately your analysis from the 90s is not of much relevance to today’s market.

      With a contested retail electricity market any gaming will see another player move in buying electricity off the spot market and undercutting the other retails. On the generation side where there is financial difficulties for a contracted (with gas) peaker the new reality will be that a more competitive plant such as a peaker with a tank of kerosene next to it that will happily come in at $300MWh when the market price would otherwise head north. In this configuration that peaker would make its money by charging a bit more just 10% of the hours of the old gas fired plant. The old plant becomes uncompetitive in the land of 1/10 the hours of generation per year. Welcome to the new reality. Bad luck if you didn’t predict that solar PV and wind are coming to reduce wholesale prices.

Comments are closed.

Get up to 3 quotes from pre-vetted solar (and battery) installers.