Energy oligopoly using market power to profit under cover of rooftop solar

The Australian Energy Market Operator has just released its excellent Quarterly Energy Dynamics (QED) report for the fourth quarter of 2019. The QED has established itself as an excellent periodic publication, full of insight and a spur to further inquiry.

One of the interesting analyses that caught our eye in the latest QED was AEMO’s explanation of coal generation by the five NSW coal plants over the quarter.

AGL’s Bayswater was down sharply – one unit out for maintenance and upgrade – but lower production at Bayswater was made up for by increased output from AGL’s other NSW coal plant, Liddell.

Energy Australia’s Mount Piper was sharply down on coal supply issues and Origin’s Eraring was sharply down, AEMO suggested (see Figure 16 in the QED), because its daytime production was displaced by higher solar output.

Comparing the production from Eraring, rooftop solar and NSW gas generators in Quarter 4 2018 and Quarter 4 2019 (see Figure 1 below) we do indeed see sharply higher rooftop solar generation: another 500 MW (i.e. a third higher) in the middle of the day in Q4 2019 than Q4 2018.

This is a remarkable rate of expansion.

Figure 1. Median 5-minute generation through the day by fuel type in NSW Q4 2018 and Q4 2019

But increased solar production is only part of the explanation. In fact a bigger part of the explanation is higher gas generation.

NSW’s two gas generators, the open-cycle Uranquity (owned by Origin Energy) and the combined-cycle Tallawarra (owned by Energy Australia), increased production quantities more than solar comparing Q4 2018 and Q4 2019.

What is more, in Q4 2019 the gas generators produced when the sun was shining, albeit less than they did in the peak period after the sun began to set. In Q4 2018, the gas generators typically only cranked up after the sun started to wane.

That solar production should displace coal makes perfect sense in a competitive market – the former has no production cost and so always best the latter in a least cost dispatch.

But that gas generation displaced Eraring makes no sense at all in a competitive market. Making electricity by burning gas at Tallawarra is much more expensive than making it by burning coal at Eraring.

The production cost gap is even bigger between Eraring and Uranquinty. Looking at Eraring’s availability we see no difference between Q4 2018 and Q4 2019.

However, looking at Eraring’s bids we see that its dispatch in Q4 2019 is explained by Origin bidding a large tranche of Eraring’s production at a much higher price in Q4 2019 than in Q4 2018.

Effectively, therefore in Q4 2019 much more expensive gas generation displaced much cheaper coal generation.

The increased uptake of rooftop solar is likely to increase the variability of operational demand variability, but higher demand ramp rates do not account for much higher daytime gas generation dispatch in Q4 2019.

Consumers have paid for inefficient dispatch, in prices that are higher than otherwise would have been the case.

Origin Energy (and other producers) will have benefitted from these relatively higher prices even though a little offset in the case of both Origin Energy and Energy Australia in higher production costs (from their gas rather than coal generators).

While more remains to be done to understand this in detail, prima facie this is yet another instance of the exercise of market power by the coal generation oligopoly in New South Wales.

The Australian Government as part of its “Big Stick” legislation (formally the “Prohibiting Energy Market Misconduct Act”) has placed obligations on the ACCC to extend its market monitoring to clamp down on behaviour such as this.

From a greenhouse gas perspective, those seeking to quickly reduce greenhouse gas emissions (and this is where our sympathies lie) might look at this outcome and suggest that displacing coal with lower emission sources of power (the sun and gas) is exactly what we should be seeking to do.

If this behavior comes about through the exercise of market power rather than an emission price, who cares, does the end not justify the means?

Well no,  the exercise of market power increases profits for the coal generators albeit that renewable generators also profit from higher prices. It provides all the wrong incentives for decarbonisation and makes large polluting power stations more valuable.

By contrast a price on emissions would reduce profits for coal generators and raise them for renewable and gas generators. Even though actual production through the exercise of market power might be quite similar to what has occurred in the absence of an emission price, the relative profits for the producers would have been quite different.

An emission price provides an incentive to expand production from low emission sources and reduce it from emission-intensive sources. This incentive encourages investment in emission reduction (and closure of coal) and that translates into lower prices for everyone.

Indeed this is exactly what we see in those European countries (and Britain) that for some time now have pursued broadly sensible emission reduction and competition policies.

Sound emission reduction policy and sound competition policy (and enforcement) are inextricably linked. The former has evaded us and the latter remains a work in progress.

Who knows what the future holds but while waiting for it, policy makers of different persuasions might agree that protecting consumers from others’ ill-gotten gains is a good thing.

The dispatch outcomes we see in the problematic NSW coal generation market merits a deep dig.

Bruce Mountain the Director and Steven Percy a Research Fellow at the Victoria Energy Policy Centre.