Know your NEM: The impact of Federal ALP policy, some speculation

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A 50 per cent renewable energy target from Labour would be trivial in terms of new project and investment requirements. But it would have an impact on coal.

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The Leader of the Opposition Bill Shorten is seen during a media conference at the Incitec Pivot Fertiliser plant on Gibson Island in Brisbane, Monday, September 3, 2018. (AAP Image/Darren England) NO ARCHIVING
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Federal ALP is expected to announce an electricity policy in the form of a National Energy Guarantee (NEG) with a higher target than proposed by the current Government  as a centerpiece of its policy on Thursday.

We expect a level around 40-50% renewables by 2030. This is still not high enough either on an Australian or, if copied world wide, globally to properly control global warming, but it would have some significant impacts for electricity in the National Electricity Market (NEM).

It would be nice to know whether there will be intermediate or even annual targets, or just a 2030 one. We favour a steady progression. Depending on economics if the industry perceives an advantage in putting everything off until 2028, and they usually do, then nothing much will happen until then.

It is, in our view, far better for consumers and the industry to have a steady flow of new investment with predictable outcomes rather than booms and busts typical of say the resources industry or the building industry. There is just no need for that here.

Our expectation is that with the investment presently committed, wind and solar energy will get to something like 22-25 per cent of total production in the NEM by say 2020.

This includes rooftop solar. It compares with about 14-15% just recently. It’s difficult to be more precise about the total as it depends on seasonality, how capacity factors work out in practice and how much further some projects have to ramp up. Our view is that a 50% target requires a further 12-16 GW of wind and solar by 2030, which is only about 1.1 GW per year.

We argue that far from a difficult task its actually trivial in terms of the project and investment requirements.

We think this would lead to a defacto market for renewable energy where uncontracted renewables will command a price and there will be constant competition to be selected as a project to be financed.

Because there will be more projects than bidders we expect pricing to be competitive and those with the best projects and lowest cost of capital to win. Access to grid connection, closeness to demand, economy of scale, ability to firm and a big balance sheet will all help.

Coal generators will compete to survive and this may drive pool prices below the LCOE (levellised cost of energy) of new wind and solar,  although we see NSW coal’s SRMC(short run marginal cost) as similar to the LCOE for new wind and solar and we expect prices to new wind and solar projects to be close to underlying LCOE.

As stated right now I’d see that as conveying a $10/MWh premium over the fuel cost of NSW coal but NSW coal also needs an extra $10/MWh to cover annual fixed costs.

Our numbers are shown below:

New investment for 50% renewable share
Figure 1: New investment for 50% renewable share. Source: NEM Review, ITKe

If demand grows more than expected then the total will increase. Although irrelevant its interesting to note that even in FY18 wind/water/solar exceeded brown coal output marginally and were going on for double gas.

If the ALP are able to have their policy passed by the Senate and it takes the form of an obligation on retailers and large users, but exempting exporters, as the Coalition policy did then the retailer share will have to exceed 50%.

Under the Coalition version of the NEG energy intensive exporters exempt from the renewable obligation  accounted for as much as 20% of electricity consumption.

Because it’s implemented as an obligation there won’t be an explicit, sponsored market in renewable certificates with formal banking  procedures, etc.

Equally if we look at what it means for coal and gas, we speculate as follows:

Coal and gas reduction under 50% NEG
Figure 2: Coal and gas reduction under 50% NEG. Source: ITKe

If you wanted to translate that into coal power stations we would start with the following candidates – noting that Eraring is not on the immediate list will certainly cut back output by say 4 TWh over the next two years and has a specified closure of 2032.

Merit order/Age closures under 50% NEG
Figure 3: Merit order/Age closures under 50% NEG. Source: ITKe

The market action

FY19 and FY20 futures have risen quite abit over the past year 10-20% depending on the State indicating no near term relief on electricity prices and likely reflecting higher than expected coal and gas prices and the slower thane expected ramp up of new wind and solar.

In addition the worrying rising in brown coal forced outage rates to 8% in FY18 is probably weighing on the market’s mind. Of course a rise in forced outage is to be expected as you go from 4 to 3 stations. That’s just statistics but at the same time its also an indication of vulnerability.

Figure 4: Summary

 

Commodity prices
Figure 6: Commodity prices. Source: Factset

Most of this data is sort of encouraging. We actually prefer high coal prices as it makes coal fired electricity less competitive but I guess its good for consumers that the coal price is falling.

Lower interest rates are good for financing projects.

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.

David Leitch

David Leitch is a regular contributor to RenewEconomy.com.au. He is principal at ITK, specialising in analysis of electricity, gas and decarbonisation drawn from 33 years experience in stockbroking research & analysis for UBS, JPMorgan and predecessor firms.

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