The NEM has been badly wounded, and the federal government has blood on its hands

For the last five to six years, maybe longer, there has been debate about what technology would replace the ageing and increasingly unfit-for-purpose and uncompetitive coal generation fleet of the National Electricity Market.

The New South Wales Electricity Infrastructure Roadmap, together with the renewable energy commitments from Queensland Victoria, South Australia, Tasmania and the ACT governments, has settled that argument for all but the die-hards.

Hats off to NSW energy minister Matt Kean who, in political terms, had legislation passed that was supported by the Liberal Party, the National Party, the ALP and the Greens. Think about that and smile. It’s a genuinely powerful political achievement. It’s what real politics is actually about. It’s much better than anything anyone has been able to achieve at a Federal level since John Howard.

The transition in electricity is gathering pace. It’s not just all these state announcements, it’s the will of business and the will of the people as expressed via the enormous growth in rooftop solar. Three gigawatts in calendar 2020, or thereabouts, is about four times as much as I had estimated a few years back.

Business shows what it thinks by putting in place PPA (power purchase agreements) deals for long-term supply of wind and or solar, even though business has to establish a new cost centre to do this and to contract for much longer than they really should have to.

In short, state goverments, the general population, and an increasing number of big and small businesses have voted with their wallets on this issue. The federal government has been left completely isolated. In electricity, at least, the idea of a gas-lead recovery is risible. It’s hard to find anyone who takes it seriously.

The next big event to happen in gas will be in early 2021, when Squadron Energy confirms the go ahead of LNG importation at Pt Kembla. That again will show what gas customers are actually thinking. And it pretty much rules out having gas cheap enough to do bulk power generation.

For what it’s worth, ITK thinks LNG imports are a good idea, cheap insurance, gas can come from QLD, WA, or the US. When we don’t need it any more, ie within the next 20 years, it’s easy to shut down. Gas is hard to replace right now in process heating and as a chemical feedstock for plastics and fertilizer. I digress.

The point of this note is three-fold:

1/ The Federal government’s lack of policy has destroyed significant functionality of the National Electricity Market. The pool price no longer is much use as an investment signal and nor is new entrant cost an indicator of what electricity prices are going to be. The above puts the case in “tell me what you really think terms” but that’s kind of where it is.

The pool price is not an investment signal because new investment is being driven by government support and state-based reliability requirements. There is a carbon agenda underlying the state approaches, but it’s only part of the agenda and it’s hidden away. Because the State may or may not bear part of the cost but its cost of capital is factored in, therefore the pool price only reflects that part of the cost that, say in NSW’s case, doesn’t end up in distribution charges. A carbon intensity scheme or much better an economy wide carbon price would have obviated all the state schemes.

2/ There is a risk of coal closures happening in a disorderly fashion, and being overly concentrated in, say, a five-year time frame. If we are no longer using the market to justify investment, is it not time to consider a different mechanism, such as the auctions used in Germany, to manage coal closures here in Australia.

3/ We also show, using NEM Review, the load shapes of generation in the NEM at the moment (when renewables are running at 30% of supply)  and show that it’s NSW and, to a lesser extent, Queensland coal that is having to do the flexing. Looking forward, the two vulnerable stations after Liddell are Vales Point, which has lots of flexibility as it has neither closure costs nor long term coal contracts, and Yallourn. So far Yallourn’s output is flat; that is, there is no sign of it having to flex up and down. On ITK numbers, new supply in Victoria is mostly wind and we don’t expect wind to increase the need for brown coal to flex. It’s solar that does that, and it will be solar in NSW and QLD, much of it rooftop. And rooftop cares not one whit what the price is in the spot market.

Disorderly coal closures are the emerging issue

The risk that is surely becoming obvious to all and sundry is that several coal stations may all decide to close within a short space of time. And by a short space of time I mean, say, three to five years.

There are mitigations to this risk:

1/ Market structure. Ownership of coal generation is concentrated. AGL and CLP both own brown coal generation in Victoria and black coal generation in NSW. They have choices. The QLD government owns most of the coal generation capacity in QLD. It can manage what it does.

2/ Revenue opportunities. The prevailing theory for coal generators is that as higher cost players leave the market it creates “head room” for the remaining players. In ITK’s view the two problems with that are (a) investors don’t want the last of the old technology, they want the best of the new stuff and (b) there is so much new wind and solar coming that any relief will be temporary and moderated. However we’d be the first to agree that our view on this could be wrong and needs much more rigorous analysis than the thought bubble style of commentary presented here.

3/ Even closed stations could be held in reserve. We can come back to this.

AEMO’s Integrated System Plan

The ISP states that in the “Step Change” scenario up to 50GW of new VRE (variable renewable energy) is required with QLD and NSW each installing 16GW and VIC 7GW by 2040. But, in fact, with the NSW roadmap we are going to be running ahead of that pace over the next decade, in NSW at least, and actually QLD announcements this year are also ahead of the pace required.

The table below shows selected coal plant closures based on what is shown in the ISP and which reflects mostly a 50 year technical life.

ITK considered that even before the NSW Roadmap announcement some plants would close before the notional date shown in the ISP. Specifically, Gladstone power station sells the bulk of its output to the Boyne Island aluminium smelter. That contract ends in early 2029 and represents a hard decision point for Gladstone. Gladstone is one of the oldest power stations in the NEM and were it known to be closing would open up large opportunities for wind and solar in North Queensland, and perhaps more hydro/pumped hydro, all of which would be valuable in a NEM context.

Once the NSW roadmap is taken into account we can make the following points. Aurora Energy, the NSW government’s modeler, specifically noted the roadmap is designed to ensure new capacity in terms of both power and energy is built ahead of the the scheduled coal generation closures, so that the plants can be closed without energy security being at risk.

However, that quite obviously means that for some years there will be a surplus. And a surplus means lower prices perhaps down to loss levels, and some coal generation units, most likely Vales Point B may not wish to go through that.

The following table shows some selected coal stations together with their expected closure from the ISP point of view, as well as their energy and median power contributions over the past 12 months.

The ones highlighted in yellow are essentially power stations where in ITK’s view there is potentially an early closure.

Even if they don’t close early there is a cluster of closures around the end of the decade. That may not be the best outcome.

The electricity market, at least the spot market, is close to dead for some purposes.

In ITK’s view the electricity function is not really being used for new investment price signals right now. Because of the federal government’s refusal to put in place credible carbon policy, state goverments have stepped in. State goverments do not, and should not, have the national interest or even the health of the NEM as a major policy driver. They are concerned to look after the interests of their state. Of course, they will consider the impact of their actions, but it isn’t the imperative.

New contracts being offered by state goverments and legislation such as Tasmania’s 200% renewable target essentially mean that some part of the cost of new supply may never show up in the “pool” or standard contract market.

On top of that is the incredible pressure being exerted by the rooftop market. If we take Sunwiz figures, and why wouldn’t we, there is now over 11GW of rooftop installed in the NEM. And that amount has doubled in just three years, That’s the part that astonished me, quite frankly.

On ITK numbers, rooftop solar at this time of the year is 10% of total supply 24/7, equal to wind, and it’s growth is more obvious just now, although wind is about to have its own burst of growth.

Across the NEM in the past couple of weeks, rooftop solar has been producing around 6.5 – 7GW in the middle of the day, as estimated by AEMO (no one actually knows for sure) and that’s around 25% of peak operational (utility scale) supply.

These numbers are not to be underestimated in any sense, but the most important to note here is that for all intents and purposes the vast majority of rooftop solar users could not care less whether electricity prices are negative $1,000/MWh or positive $10,000/MWh. The systems just produce power willy nilly.

For rooftop solar the electricity market is so irrelevant that the vast majority of users would have only the haziest of ideas it exists at all. And yet it represents more or less 20-25% of supply in the middle of the day and as I say 10% of total supply during Summer. And it’s still growing faster than the wisteria out front.

So, between investment which is now more driven by state decarbonsiation policies than actual price signals, and consumer preferences for price insensitive rooftop solar, what is the function of the spot market?

Its one remaining job seems to be to work out what firming energy will be supplied at dinner time every evening. Of course that is hyperbole, but it’s the direction we are heading.

Looking at the fuel shape and coal ramp when renewables are 30%

Solar, rooftop and utility, is about 14% of total output in the past 30 days, up from 12% this time last year. Wind is another 10% and hydro, including Tasmania, 6% so that’s 30% in total.

The following figures show how the main fuels are supplying the load.

Points to note are:

Black coal and as we see below, NSW coal, is doing the flexing. Hydro and gas are very similar in shape and individually are less than wind these days. Rooftop solar is much more important than utility solar right now.

Let’s unpack the coal generation. ITK, and no doubt every other modeller forecast that because NSW coal is more expensive on a variable cost than QLD or Victoria that essentially excess supply would want to flow to NSW an its NSW power stations that would have to either take lower prices or reduce volume. So far they are choosing lower volumes.

We can see that NSW coal is managing and evening peak ramp (low to high) of about 1700 MW, QLD a little over 1000. There is just the barest hint of a Victorian brown coal ramp.

The pressure on Victorian brown coal will come from solar

The next major events in the system are the combined 800MW of wind from Moorabool and Stockyard Hill, more output from constrained wind and solar systems across the NEM, ongoing commissioning of new plant and then the closure of Liddell.

ITK identifies Vales Point and Yallourn as being the most likely stations to close following Liddell’s exit. Their recent performance by hour of day is shown below:

1700MW new supply in Victoria underway

Stockyard Hill is a 530MW wind farm. It was in development for many years by Origin and eventually in May 2017 a PPA with Goldwind was announced. Production was originally planned to start in October 2019, but production has been delayed by over 12 months. Greg Jarvis’s ORG investor day slides noted production was now expected in 2021.

Although the 312MW Moorabool wind farm is now registered as a producing asset, it did not in fact sell any wind generation in the past 30 days. As of November 23, none of the Southern Section turbines had been commissioned. So still a bit of work to go.

Although the largest, they are only two of the 11 committed projects yet to start producing in Victoria.

The good news for brown coal is that wind output in the region tends to drop a little in the middle of the day, creating more space for coal and solar.

Of course wind output is much more variable day to day than the average, but on average that’s about the same output as say LYA.