No carrot, no stick: Why Australian renewable projects are stalled

Australia’s large-scale renewable energy industry is stuck between a rock and a hard place: Despite legislation and an apparently firm 2020 target, and soaring prices for renewable energy certificates, the market remains at a virtual standstill.

A whole slew of reports have been issued in recent weeks trying to analyse the situation. The latest, from UBS, suggests that the market remains stalled because the biggest electricity retailers (also known as gen-tailers because they have large generating plants) have little reason to invest – they suffer no penalties if they don’t invest, and risk cutting earnings from their existing fossil fuel plants if they do.

“Existing gen-tailers that have large generation assets and retail customer bases) are less than fully incentivised to introduce new supply,” a team led by UBS analyst David Leitch writes.

It notes that AGL, with a heavy bias towards coal-fired generation in the Latrobe Valley (Loy Yang), and NSW (Bayswater and Liddell) would lose $25 million for every $1 fall in the electricity pool price. (More renewable energy lowers wholesale electricity prices).

“But the liable entities (electricity retailers) suffer no particular financial disadvantage for not meeting the target,” UBS notes. “The higher prices can just be passed onto consumers. For consumers, even non exempt industrial consumers, the renewable cost typically makes up only a modest portion of the electricity bill.”

This lack of stick or carrot has left the market seemingly well short of its target, and prices of LGC (large-scale generation certificates) have soared to more than $80/MWh on the assumption that their will be a major shortfall as soon as 2018. Some retailers have already fallen short of their 2015 target, as detailed here.

This price surge should, in combination with a wholesale electricity price average more than $50/MWh is most states, provide sufficient price incentive for renewable energy developers. Yet this has not been enough to attract contracts or finance and kick off investment.

UBS estimates that more than 7,000MW of wind and solar is needed to meet the 2020 target, but there is only 1,000MW of capacity on the horizon – all of these from government tenders and none from the private sector.

What’s more, much of this capacity will be for voluntary schemes – such as the ACT reverse auction program – where the certificates are surrendered and are additional to the federal target. So, the 200MW of large-scale wind to be built for the ACT won’t count towards the national target.

There has been increased talk, but little activity from the major retailers about signing new contracts, apart from Origin Energy speaking about the plunging price of large-scale solar and AGL Energy announcing a new financing vehicle to build 1,000MW of capacity.

But while AGL’s renewables announcement has been hailed as a “shift to green” it does little more than seek to attract co-investors to spread the financing risk to achieve a target it was already obliged to meet. It still only intends to write contracts for a 5 to 10 year period.

And, as Morgan Stanley’s Rob Koh noted in a separate analysis last month, AGL may not choose to go ahead with its most obvious developments, such as the Silverton wind project near Broken Hill, which could be as big as 1.5GW, because of its potential impact on its NSW coal assets. Nor might it support a wind farm in Victoria because of its potential impact on its brown coal generators.

It might, though, support more wind in South Australia because “increased intermittency in South Australia would benefit AGL’s gas-fired Torrens Island Power Station. Koh suggests that AGL may bid a new gas peaking plant into the current tender being conducted by the South Australian government.

The lack of long-term contracts is a problem for developers, investors and financiers, and contrasts with the long-term price certainty offered by the ACT and by equivalent schemes oversees.

UBS says the combination of the LGC price and the wholesale market should make it attractive to build renewable energy. In NSW and Queensland, based on current futures prices, the “bundled price” is equivalent to $130-140/MWh.

This should be more than enough to build a solar farm in Queensland or a wind farm in NSW. UBS estimates that the price needed to get a 6.3 per cent internal rate of return on a solar farm in Queensland is $105/MWh, while for a NSW wind farm it would be around $80/MWh.

But the lack of any long-term signal means it is difficult to attract finance. Assets such as wind or solar farms expect to have a life of 25 years, but the renewables target mechanism finishes in 2030, meaning these assets will only have access to this revenue for 13 years (given most will not be built until 2017/18).

After 2030, the renewable energy projects will have to rely on the “black” or wholesale price of electricity only. But there is also uncertainty over the previous decade – if not quite enough renewable supply is built, prices will remain elevated, but if a bit too much supply is built so prices (for LGCs) will go very low.

UBS suggests that one market that may emerge in Australia is corporate buyers. These companies, such as Apple, Facebook, Google and Dow Chemicals, now account for more than half the contracts issued in the US market.