Know your NEM: NEG supporters talk their book, ignore climate

This will be the last piece I write on the National Energy Guarantee for the interim. There is too much else going on to stay on this topic.

Nevertheless during the week, the NEG continued to be debated. Specifically, the Energy Security Board held another of its forums.

Representatives of the following stakeholders made formal comments at the forum:

South Australian Government, St Vincent de Paul, Powershop, Origin, ERM, Schneider Electric, Snowy Hydro, Minerals Council of Australia, Alinta, Clean Energy Council, Energy Users Association, Engie, Energy Consumers Australia, Greensync and Australian Energy Council.

There was not one stakeholder there with climate change mitigation as a primary focus. Customer representatives want lower prices, generators want their form of generation protected etc, but for none of them is climate change mitigation something in their own KPIs. That said:

−     Each of the stakeholders supported the NEG.

−     Each praised the ESB for the work done.

−     Each pointed to one or another remaining technical issues.

Each and every one of these stakeholders, with the possible exceptions of Schneider, Origin, and ERM, essentially talked their book. As a stockbroking analyst I like to give points for how well management talk their book, how sincere they sound, the disingenuous quotient.

Jeff Dimery from Alinta won my gold award here with his support for “offsets” helping to save consumers money.

Certainty leading to lower prices was the overwhelming basis for support

Basically, each stakeholder expressed support because they believed it would provide “certainty”. For the most part they believed this certainty would lead to lower prices. Not one stakeholder explained how the “certainty” would lead to lower prices, but we will come back to that.

Several stakeholders also expressed that they were “technology neutral”. Let’s get one thing absolutely clear, you can’t equally prioritise being technology neutral and decarbonsising the economy.

It so happens that variable renewable energy [VRE] – i.e. wind and solar – is cheaper than new coal or gas at the moment on an LCOE basis but this is far, far from a sufficient condition to get the electricity sector, never mind the broader economy, decarbonised.

Your analyst believes that pretense around technology neutrality will lead to ongoing mistakes about the generation mix in ten years time in the NEM and all that goes with that.

The NEG provides certainty of mechanism

We agree with stakeholders that the NEG emissions reduction leg provides certainty of the mechanism for carbon reduction. It is a form of Emissions Intensity Scheme.

These schemes are not used much in the rest of the world but the AEM, the rule-maker,  likes them so that is what we have. We also agree with comments made at a different forum that:

1. Climate policy introduced by the Coalition tend to be more enduring than policy introduced by a Labor Govt. My Grandad used to make a similar point, although not about climate policy. Small L policies introduced by conservative govts tend to endure because they own it, those introduced by left wing govts are torn down by conservative govts and vice versa.
2. It’s easier to change the emissions reduction target for a subsequent Govt than to get a scheme and a tough target into Federal Law. Given the 3 year Federal Govt. cycle and Senate composition this point does resonate.

The Emissions Reductions Target lacks credibility and therefore does not provide certainty

A 26% emissions reduction in electricity by 2030 lacks credibility. Firstly, it will not achieve the COP 21 target. See section below. Secondly the ALP states that it will pursue a 45% target by 2030. The ALP has a 50% renewable target by 2030 at a NEM wide level.

There will be Federal elections in the 2018/19 window, 2021/22 window and 2024/25 window. If the ALP were elected at any of these elections it would have an opportunity to get the NEG target changed.

As it stands the only certainty of the new policy in the short term is that it will not lead to any new investment.

The target will not of itself induce any new investment

We have covered this before. We are not aware of any analysis that suggests there will be much new investment needed to get a 26% reduction from 2005 levels. Investment therefore will have to come either from market signals or State targets.

If the ESB modelling is correct and the NEG results in lower electricity prices (and we can’t really see how), then almost definitionally it will act as a disincentive to new investment. That after all is how price signals work. In our view this actually increases risks, particularly in NSW.

Lower electricity prices also incentivise higher consumption and reduce incentives for behind the meter investment.

Falling prices will initially result in less investment but may bring forward coal generation closures

Forward electricity prices are set to fall. The market’s current expectation is that, eg NSW base load futures will fall from a 2018 level of $80 MWh to $62 MWh by 2021 before rising to $73 MWh by 2022. That might translate to a 10% price fall for large customers and 5%-6% for households.

For NSW coal generators though it will be a problem.  One way to look at this is via the accounts of Sunset Power, which mainly operates the Vales Point B generator in NSW. The table below shows the FY17 and annualized FY16 P&L for Sunset.

I have added in coal consumed (sourced from NEM Review) and pool price outcomes (sourced from NEM Review)

Figure 1: Sunset Power P&L. Source: ASIC, ITKe, NEM Review

Focussing on FY17 the actual sales revenue received was $47/MWh compared to a pool revenue of $79.8 MWh. The difference is contracts, presumable written  before Hazelwood closed.

The expectation a year ago, and still largely true, is that as those contracts rolled off and were replaced by contracts at more or less the baseload futures prices there would be a profit explosion.

The fly in the ointment is coal prices. Last week I, half jokingly, asked for some assumptions about GJ per tonne of coal and several readers made insightful comments.

For the record I historically have used around 26-28 gJ/t for export coal using, say the Ulan mine EIS as an example. In any case NEM review provides an estimate of coal consumed for actual output.

If electricity futures prices fall back towards $65/MWh and if Vales Point had to pay 2018  export price for coal it would likely lose money.

And that’s before considering a likely 2022 refurbishment. However, ITK is not suggesting Vales Point will have to pay export parity price for coal, merely to illustrate the supply risk if it did. Note that Sunset Power’s non Vales Point overheads are implicitly added to the following figure.

Figure 2: Vales Point coal and electricity price sensitivity. Source: ITK

There is much, much more to be said about NSW coal generation including ORG’s 45% renewable commitment, but the main point remains that the NEG will not assist with its replacement.  That is left to the traditional energy only market and its contracting mechanisms. There is much more to be said on this topic.

Conclusion: If the NEG had a jointly agreed target it would provide certainty. But it doesn’t

If the Coalition had negotiated a jointly agreed target with the ALP in the same way that the RET target was negotiated the electricity industry would indeed have had a level of certainty. As things stand though we don’t see that it does.

It is hard to see how the NEG will result in lower electricity prices because it will not induce any new investment because the emissions target is already effectively met.

However, we can see that electricity prices will fall as a result of investments made under a combination of the LRET scheme and the price signals that followed the closure of Hazelwood.

The reliability leg of the NEG is a more or less explicit recognition of the possibility of market failure. That is that the energy only market cannot be relied on, on its own, to always have enough supply to prevent unserved energy risk exceeding standards.

Its our view that stakeholders still have reservations about the technical side of this part. My observation is that much generation may be left on the table as available but in fact not be available much of the time.

A clear case of this is say Pelican Point which simply didn’t respond to short term price signals in South Australia because it didn’t suit management’s longer term interests.

Finally for today I’d note that the NEG is but one of a range of policies that are going to make “energy only” price signals very hard to rely on.

Never mind that spot price signals are irrelevant to zero marginal cost renewables, it’s more the implications of State policies, five minute settlement (and its impact on open cycle gas generators) and the Integrated System Plan. Even the ACCC may make an impact although history is against it.

NEG will get up, but investors will focus on state targets and the federal election

In the end though its clear enough that the NEG is some form or other is going to get up. What does that mean for investors? Little or nothing. It means that they still have to wait and see who wins the next election before any more investment decisions under Federal policy can be considered.

It means that State targets in Victoria and Queensland are more relevant. In Victoria we are going to see $1.5 billion of investment announced this month under the VRET. In Queensland, I expect Genex to add to its $500 million NAIF commitment with some form of Queensland Govt involved PPA that will lead to $800 million of investment.

Australia and the world’s Paris commitments

In case anyone has forgotten the COP 21 target was

“”The central objective of the Paris Agreement is its long-term temperature goal to hold global average temperature increase to “well below 2°C above preindustrial levels and pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels”.

This goal is linked to a requirement in the Paris Agreement that all countries work together to bring greenhouse gas emissions to zero within the second half of the 21st century. Australia has signed up for that.

Australia’s NDIC firm commitment to reduce economy wide emissions by 26-28% by 2030 from 2005 levels is insufficient to achieve the broader goal.

“There has been no improvement in Australia’s climate policy settings over the last year, and the 2018 CAT assessment confirms all previous assessments that its emissions are set to far exceed its Paris Agreement NDC target for 2030.

We rate the NDC target itself “Insufficient“, with a level of ambition that—if followed by all other countries—would lead to global warming of over 2°C and up to 3°C. In addition, if all other countries were to follow Australia’s current policy settings, warming could reach over 3°C and up to 4°C (“highly insufficient”).

While the Federal Government continues to maintain, most recently in its “2017 Review of Climate Change Policies”, that Australia is on track to meet the 2030 target,the Climate Action Tracker is not aware of any factual basis, published by any analyst or government agency, to support this.

To the contrary, Australia’s emissions are increasing, and the latest projection published by the government at the same time as the Climate Policies Review shows that emissions are still projected to grow instead of leading to a reduction in line with the 2030 target”

Source: Climateactiontracker.org

The market action

Figure 3: Summary

Figure 4 Cap prices. Source: NEM Review

Figure 5: Commodity prices. Source: Factset

Share Prices

Figure 6: Selected utility share prices

Figure 7: Weekly and monthly share price performance

Volumes

Figure 8: electricity volumes

Volumes

Figure 13: Baseload futures financial year time weighted average

REC Prices

Figure 14 Source: Mercari

Gas Prices

Figure 15: STTM gas prices

 

Figure 16 30 day moving average of Adelaide, Brisbane, Sydney STTM price. Source: AEMO

 

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.