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Is Rod Sims having a lend of us?

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The ACCC report into electricity represents yet another Government Body attempting to set policy. As if it wasn’t enough to have the AEMC, AER, AEMO and ESB as well as various State apparatchiks in their cubicle farms, we now have the ACCC weighing in.

Each of these bodies will be growing employment and handing out work to consultants. However, as is often the case, one suspects it’s the law firms who will be making the most hay.

In our view, the ACCC has done a good job shedding light on some of the darker places within the electricity industry. We support moves to take the BS out of retail contracts and to increase disclosure of the OTC contract market.

We think attribution analysis of the electricity price increase is useful, although it’s neither new nor surprising. We all know network and gas prices have gone up and there has been a temporary, I say temporary, reduction in supply.

However, the forward-looking recommendations range from the unrealistic – state government handouts – to the downright dangerous – federal government subsidies for new dispatchable generation. And the policy recommendations in several cases run across the policy work coming from the ESB.

Coal cost disclosure the most useful part of the report

Disclosure around state aggregate actual coal costs is also very useful.

For instance, it was able to obtain information on the actual coal costs paid by NSW generators.

Figure 1: NSW coal costs. Source: ACCC

The ACCC converts the coal $/t to $/MWh using their coal quality and thermal efficiency assumptions to get a NSW coal cost of $30/MWh at contract in Q1 2018 or $50/MWh using export spot price.

The ACCC also notes that coal stockpiles have reduced. $30/MWh is certainly a low number. A lot less than the futures price in NSW of around $75/MWh in 2022.

It’s possible to read Figure 1 (above) in a couple of ways. Here at ITK we expect that each generator has some contracts at a set formula  that increases each year, possibly by more than CPI, and supplements this with spot market purchases.

Because of quality differences, even spot market purchases are at a lower price than the spot market, but then more of the coal has to be purchased.

Therefore, there is still judgement and uncertainty as to what will happen when the existing contracts roll off. We don’t expect prices to rise to export levels, but they could go from the existing 53 per cent of export to say at a guess 75 per cent.

If this happens when pool prices are falling it will be a problem.

On top of that we don’t think new coal mines in NSW can be built, if at all, and make money at prices less than $100/t.

If NSW black coal continues to set prices in the NEM, that’s one line of analysis to keep in mind. Of course, export prices could fall.

This would happen if global coal supply (translation Chinese domestic supply) picks up or global demand (translation fall in Chinese demand due to say a housing downturn) fell away.

Even Rod Sim’s own numbers don’t support a $45/MWh reserve price.

The ACCC suggests at page 100:

“The Australian Government should operate a program under which it will enter into low fixed-price (for example, $45–50/MWh) energy offtake agreements for the later years (say 6–15) of appropriate new generation projects which meet certain criteria.”

We state, as fact, that a NSW black coal generator could not be built that would earn a return on capital at a $45/MWh electricity price.

We would go further and say that the ACCC has no real business suggesting this. We aren’t aware of any commercial analysis that comes up with a number at least 50% and typically 100% higher than the ACCC’s suggestion, at least in NSW.

But in any case if Rod Sims really does believe this, it’s no wonder he ended up as a bureaucrat. It may make sense in Queensland, although I doubt it, but then there is no transmission.

In NSW you have as much chance of getting a $45/MWh coal plant up as, say England does of winning the world cup in 2018. You wouldn’t even have a positive contribution margin let alone pay off the capital.

Figure 2: New NSW coal generation at $45 MWh. Source: ITK

You can’t be technology neutral and still have a decarbonisation agenda

It’s just a nonsense. If you have an emissions intensity scheme (of which the NEG is a bastardised version) you are insisting that some generation be low carbon. That is not technology neutral.

And nor is there any point in going with just a 26 per cent reduction only in the electricity sector. That will hardly be enough to hold Australia’s overall emissions constant.

Whoever is responsible for system reliability, it’s not individual generators

Via the Finkel Report and subsequent deliberations, the ESB has had a careful look at who should be responsible for system reliability.

The ESB has concluded it’s the responsibility of retailers and major customers.

The ESB specifically came down against a generator reliability obligation. Yet now we have the ACCC suggesting the federal government should only subsidise “dispatchable” generator.

This is a nonsense on several levels. The reality is that system reliability is a system operator’s responsibility and that the quantity of dispatchable generation or demand management is something to be determined by AEMO.

It’s certainly got nothing to do with the federal government, per se, and if the federal government is going to only subsidise dispatchable generation, we can pretty much guarantee the system will end up with sub-optimal allocation.

Of course, dispatchable generation doesn’t just have to be coal or gas, it could be some combination of wind PV with a firming component up to and including demand management.

The ACCC have suggested that the CEFC could be the funding body. Your analyst actually suggested, and wrote a note two years ago on using the CEFC to run a rolling program of reverse auctions to provide a steady stream of new renewable capacity.

This was not a technology neutral idea and was based on a planned approach to decarbonisation and also allowed for the increased flexibility that fast build wind and  PV provide in adjusting new supply to changes in demand.

Bastardising this idea to support new coal stations at unrealistic prices shows how little it takes to move from a sensible policy suggestion to backwards looking nationalisation of the electricity industry.

$23 n of investment and counting and the market doesn’t work?

According to the Sydney Morning Herald [SMH] the Prime Minister said

the watchdog had found it was hard for new players to get financing for new generation projects

What a load of cobblers.

According to my numbers there is about 3GW of wind and 3GW of utility-scale PV under construction/commissioning in the NEM. A reasonable number is $2m/MW which is around $12 bn of investment. The PV cost is lower today but $2/m is a reasonable overall number.

Of that $12 billion less than $3 billion could be attributed to the big 3 gen-tailers.

On top of that there is, say, 1GW a year, give or take, of behind the meter PV where the pre-SREC cost is probably around $1.50-1.80/w or about $1.5 bn per year, maybe more. Over three years that’s another $7.5 bn.

So on my numbers we’ve seen close to $20 billion of new generation spend in the past three years.

If that’s hard to get financing I’d hate to see easy financing.

On top of those numbers we can add $500m of gas generation by AGL, 100MW of coal for maybe $160m and the  $4bn Snowy 2.0 project,  and we get to over $20 bn of new generation financed.

Figure 3: The generation investment boom. Source: ITK

More investment is on the way if the market is left to its own devices.

As for ownership the figure below only went to the end of  2017 and there has been changes of ownership at various projects since, but it still serves to give a flavor for the variety of developers just for the wind & PV projects. There is plenty of new players.

Figure 4 New wind & PV developers as of 2017. Source: ITK

In previous notes I’ve spelled out the individual wind & PV projects that make up these totals.

This investment will produce a little over 10% of new energy, ie around 20 TWh in a 200 TWh NEM wide market. Yes some of it will be required to replace Liddell and some is replacing Hazelwood. This set of numbers does NOT include the Victotorian VRET

High prices are as normal as low prices in a market

Believe it or not high prices are clear evidence of the market working

The fact that prices go up is not, it is NOT, FFS, evidence of market failure. It is evidence that demand exceeds supply, in this case supply fell, and signals an opportunity for new investment. And that is what happened.

It happened with a lag and we’d be the first to agree that prices have been volatile and that markets can over and undershoot.

The oil price has excellent levels of  global competition but the price has varied from about US$110 barrel to around US$30 a barrel over the past five years.

Does anyone complain this is a rigged market? And don’t try telling me that oil is not an essential service. Maybe its less essential than electricity but not by much.

Why did all those coal generators close? Low prices

People forget it was only in 2015 that low prices lead to the closure of Northern Power Station, of Wallerawang, the temporary closure of Tarong, the mothballing of various gas plants (Swanbank E, Pelican Point) and eventually the closure of Hazelwood.

The low prices lead to the Queensland Govt manipulating the market by merging its three government-owned generators into two. The NSW Government sold Vales Point B for $1m because nobody else wanted to buy it. The closures were not because of carbon costs.

In fact the carbon compensation scheme of the Gillard Government arguably kept Hazelwood open for longer than otherwise. The closures were almost exclusively due to prices being too low.

Did anyone complain about the market then? Was there an ACCC enquiry? No, of course there wasn’t. The existing generators just had to suck it up.

Big customers now the first to complain ended up, I suspect, going naked to the market and not hedging because they thought they had a God Given right to low prices for ever.

David Leitch is principal of ITK. He was formerly a Utility Analyst for leading investment banks over the past 30 years. The views expressed are his own. Please note our new section, Energy Markets, which will include analysis from Leitch on the energy markets and broader energy issues. And also note our live generation widget, and the APVI solar contribution.

  

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  • Ren Stimpy

    Awesome article.

  • Andy Saunders

    “system reliability is a system operator’s responsibility”

    Amen to that! And yet so many people want to take a different view!

    • Ray Miller

      Agree also AEMO should have the customer’s back.

      But as has been pointed out most of the customer outages are in the LV distribution network’s which is effectively no man/woman’s land..

      • Andy Saunders

        Yes.

        It’s interesting when I ask people 2 questions when was their last blackout (usually – except SA! – quite a few years ago), and then how often did they have blackouts in their childhood (depends on their age, I guess, but the answer is often a few times a year).

        No-one will notice a small change in reliability from one year to the next, but it sure adds up over decades.

  • BushAxe

    Good article David. AEMO’s ISP modelling assumptions use @$3m/MW for new black coal, so it’s obvious unless a plant is built for free and uses heavily subsidised fuel its never going to be competitive.

  • Nicko

    Great read for a non-specialist like me.

    Can I suggest an extra row in Figure 1? “Weighted Average NSW Renewable Generation Fuel Costs” $0 in each year from 2015 to 2018.

  • Ian

    Anti-Australian Coalition Coal Conspiracy: this hatchet-man certainly came out from the blindside with a coward-punch. Advising 1. New coal generation and 2. Getting rid of the SREC.

  • Pete

    Great analysis again. The BS test is so vital in analysis and I always enjoy reading your articles because of the well informed constructive criticism you provide us.

  • juxx0r

    Christ that’s difficult reading. Figure 2, what a clusterfuck. You’ve got Millions of dollars, and Milli dollars and unit less numbers all in the same table.

    • David leitch

      I apologize. I hope you were able to struggle through that difficult table without too much brain or eye strain.

      • juxx0r

        You have improved.

      • Shilo

        I am wondering if David you could do a cost of the current operation at both Millmerrian and Kogan Creek in queensland.
        I am guessing they currently cost all up including everything less than $30per MWH. (Kogan say 5 or a bit more than Mill due to extra time mill has had to remove some debt)

        Allowing for around $2billion each to expand by double, they may be able to sneak in under the $40 all in cost.
        So even they cannot expand because a $5 or $10 margin is not enough?

  • Hettie

    You are angry, David, and with good reason. So much unmitigated fuckwittery going on. Ill informed bureaucrats making stuff up, too lazy to do their homework.
    This is the only planet we have. Mars will not be ready before Earth dies, so we have to rescue Earth somehow, and these airheads are determined to get in the way..

    Where do the fossil fools think they are going to live when the earth is totally fried, I wonder. And what are they planning to eat and drink? The supplies of Bolly and single malt will run out, and as far as I know, Sturgeon are hard to find on Mars. The stupidity is indescribable.

  • Peter F

    Excellent analysis David as usual
    Two quibbles.
    1. By the time a new coal plant comes on line unless it drives out other coal plants the utilisation will be closer to US levels (53%) so its annual sales are more likely to be about 12 TWh
    2. As BushAxe says, $2 m/MW is far too optimistic for new coal. Somewhere between $3 and $4 m is the right figure if you include project finance

  • Les Johnston

    Very helpful analysis of the SIms proposal. I agree that Sims has failed to apply critical analysis of all aspects of the electricity market. Those weak areas enable half baked proposals. It is a pity he did not examine all costs and subsidies given to different components of electricity delivery. The claim of inability to obtain investment funds made by our Prime Minister seems quite hollow when all the private renewable energy projects are tabled. The blunt coal mining costs make coal fired generation a high cost option even without considering health costs imposed on residents living near generators.

  • Ray Miller

    Spot on David, keep up the frank assessments.

  • Shilo

    I am wondering if David you could do a cost of the current operation at both Millmerrian and Kogan Creek in queensland.
    I am guessing they currently cost all up including everything less than $30per MWH.
    In fact I would say its more like sub $30.
    Allowing for around $2billion each to expand by double, they may be able to sneak in under the $40 all in cost.
    So even they cannot expand because a $5 or $10 margin is not enough?

  • derekbolton

    One quibble. You write
    “If you have an emissions intensity scheme … you are insisting that some generation be low carbon. That is not technology neutral.”
    Any technology is a solution to a specified problem. If the specification includes a limit on emissions then you can have any technology that meets that criterion. Neutrality consists of not imposing additional constraints beyond those intended.

    • Hettie

      A quibble indeed!

  • Jonathan Prendergast

    Great stuff David.

    In a way, could Simms and yourself be making the same recommendation? Reverse Auctions for PPAs by the Federal Government to provide certainty for the investment?

  • Rod Hardagain

    Your numbers are as good as your spelling.

  • Rod Hardagain

    I think its simple. Make your renewable generation non-intermittent and dispatchable, register in the market as scheduled generation. No more semi-scheduled rubbish.