AGL Energy, one of the first companies to articulate the “merit order” benefits of renewables, is now threatening to withdraw from activities in South Australia, the state with the highest penetration of wind and solar in the country, if it is forced to pass on some of those benefits to consumers.
A big brawl has erupted between AGL Energy and the Essential Service Commission of South Australia (Escosa), over the pricing regulator’s recent draft decision to force AGL Energy to pass on the benefits of lower wholesale prices to consumers on standing contracts.
Escosa argued that the wholesale price component had been too high, because it had been set according to energy industry estimates of the long-run marginal cost of energy. However, it said wholesale prices have fallen and recommended a change that would reduce the wholesale price component by $27/MWh, which would result in savings of around $160 a year for consumers in South Australia.
AGL Energy, however, says if the decision is upheld, then not only will it scale back its marketing activity in the state, including cessation of all door knocking, it will also suspend any further investment in power generation, including renewable energy, in South Australia.
“ESCOSA has effectively put up a sign saying do not invest in South Australian power generation,” managing director Michael Fraser said in a statement issued ahead of the company’s annual general meeting.
The “merit order” effect is a well documented impact that wind and solar energy has on the price of wholesale energy. Because these energy sources have a very small short-run cost of energy, because their fuel is free, they get priority in the bidding order of national electricity markets, bringing prices down.
AGL Energy was one of the first to sing the praises of the merit order impact when it was advocating for a higher renewable energy target before the election of the Labor government. However, it has been a bit quiet on the merit order impact lately, particularly in its recent campaign to have state-based feed-in tariffs for solar cut back.
Escosa, surprisingly, did not cite the impact of green energy in its draft finding, pointing only to a reduction in demand. But, as Dylan McConnel from the Melbourne Energy Institute pointed out, the amount of wind energy and even rooftop solar in the state – both the highest in the country – are clearly having an impact. He said it was possibly the first instance where the merit order was passed on in a regulatory ruling.
Certainly, the impact of wind and solar on wholesale energy prices is well established in international markets, and has been behind the argument of most of the major Australian utilities in diluting the renewable energy target. They say too much wind and solar will make coal- and gas-fired generation uneconomic. On the other side, most pro-renewables companies have said the merit order impact is a benefit.
AGL Energy straddles both sides of the argument, because apart from renewables investments, it has coal-fired generation, and is a retailer. It has been the only major utility to support the LRET as is, despite its equivocation on solar PV. However, this attack on Escosa’s ruling is as much about defending its retail margins, and it’s “gentailer” business model. It says the combined impact of regulatory rulings in South Australia and Queensland on retail prices could be $60 million on an annualised basis.
As one energy analyst noted: “It is actually quite well documented in the merit order effect literature that in cases of strong vertical integration (or weak competition), that firms are able to internalise the merit effect – which is perhaps what AGL has been able to do in SA – until now.”
But while AGL Energy is keen on pocketing the increased margins, it is also highlighting an uncomfortable reality for the renewables industry – that is, that if the wholesale price continues to be set by the short-run marginal cost, then eventually it could dissuade investment in renewables as well.
These are some of the issues being confronted in Germany at the moment. And they promise to be some of the most critical and fascinating regulatory arguments into the future – if they can be heard over the short-term rhetoric, and some of the nonsense, that is said and written about energy prices in the political arena. As another analyst pointed out, having a market based on the lower short-run marginal cost (which is what Escosa is arguing) has proved to be efficient in the National Electricity Market since its inception more than a decade ago. It was considered a really good thing, until wind and solar came along to spoil the party for the coal-fired generators.
Now, AGL Energy is arguing that if the regulator sets the retail price below the long-run cost, power purchase agreements become uneconomic and so does investment in utility-scale renewables, since renewables are long-dated investments and need long-run pricing.
AGL Energy’s position is also a calculated part of a broader campaign on price regulation in the industry across the country, particularly in Queensland where AGL Energy and other utilities are fighting against artificial retail price caps. AGL Energy says it has stopped marketing activities in that state, and is also considering doing the same in NSW, where that state’s market regulator has also been instructed to build in market prices into its estimate for the wholesale price component of retail bills. It has been pushing, along with other utilities, for a deregulated market, particularly in time-of-use tariffs.
But the response to Escosa, and its apparent wish to pocket gains of the merit order impact, is not the only mixed message sent out by AGL Energy in recent months. The company that built a reputation for creating the cleanest energy portfolio in the country, with the largest investment in renewables, earlier this year bought the country’s largest single emitter, the Loy Yang A power station.
AGL justified that decision by saying it was too good an opportunity to miss, and that earnings generated by Loy Yang A were better in its hands, as they were more likely to be directed towards green energy. The earnings power of Loy Yang A, which AGL Energy has refinanced using its own balance sheet, was underlined in its latest update, which included a significant upgrade to its earnings this year – to around $590 million to $640 million, compared with $482 million in the last fiscal year.
However, company chairman Jeremy Maycock, said the regulatory decisions, combined with the uncertainty around the future of carbon pricing and the LRET, meant that “no one should be surprised to see new investment in the NEM (National Electricity Market) evaporate, with all the consequences that would follow.”
He said the continued regulation of retail prices and overlapping state and federal regulatory structures “creates a real risk of systemic failure” in the NEM. But this is part of AGL Energy’s problem, it is effectively arguing for deregulation in one part of the market, and reinforcing regulations in another. The one thing that has been consistent in all this energy debate: everyone has been talking their book.