Why fossil fuels love capacity markets: $11.4 million for three hours work | RenewEconomy

Why fossil fuels love capacity markets: $11.4 million for three hours work

A fossil fuel generator in W.A. has received more than $10 million in annual payments even though it is switched on for just a few hours a year – much of that just to show it works.


It’s the dream, I suppose, for many of us: How to make bagfuls of money without having to get out of bed. Some fossil fuel generators have developed a gift for doing just that, and that gift is known in the industry as capacity markets.

In West Australia, there is an 82MW “peaking” diesel generator in the wheatbelt town of Merredin that was built in 2012 and has been rarely used. But that hasn’t stopped it from making heaps of money.

In 2018/19, it looks like Merredin Energy earned some $11.4 million – or $138,760.39 per megawatt of capacity.

And in that 12-month period, according to the latest AEMO report on the state of the market, the Electricity Statement of Opportunities for the W.A. market, (table 43), the Merredin plant produced just 260 megawatt hours, or the equivalent of just over three hours of full production. And most of that was for the regular twice-yearly testing to make sure the equipment works.

RenewEconomy foreshadowed this situation way back in November, 2012, when we wrote:

The Perth-based company Merredin Energy is in the throes of completing an 82MW peaking plant near the wheat-belt town of the same name. It is being built at an estimated cost of $95 million and proposes to use expensive and highly polluting diesel fuel, but it may never be switched on.

And if it isn’t, its owners might not care – under WA’s capacity payments system, they’ll likely make enough money simply for being there – around $15 million in its first year. In fact, they might prefer if the plant wasn’t used. Some analysts suggest it would be difficult to run the diesel plant at a profit – even during critical peak periods – given the sky-high cost of diesel and the fact that WA power prices rarely jump to more than $300/MWh.

See our story: Dumb and dumber energy choices in the wild West

As it turns out, it has been switched on, although mostly for maintenance purposes, to check if the equipment still worked. An audit by the WA energy regulator noted that the Merredin generator “runs on average for around 10 hours per year,” although it suffered problems on occasions on starting up and synchronising its turbines (see page 22).

Merredin is not the only facility to enjoy these capacity payments for minimal output. Over the last two financial years, four 9.9MW diesel generators owned by a company called Tesla Group (no, not that Tesla) have likely earned more than $10 million combined for next to zero output, apart from the required testing.

Capacity markets have been a feature of the W.A. market for many years, ostensibly because it is a “peaky” market, where demand can swing wildly, particularly in hot weather.

The Merredin installation justified itself at the time by claiming that wind farms needed back-up on a 60:100 basis. I.e. for ever 100MW of wind, some 60W of back-up generation was needed. Those claims are still on its website. Right across town from the diesel generator is the 207MW Collgar wind farm. But it hasn’t needed the diesel plant at all. Neither has the grid operator.

Peaking plants and fast start generators do have a role to play, even if they are very rarely used. Many, like Infigen Energy’s Smithton peaking plant in NSW operate only for around 100 hours a year, and in an energy only market they get paid handsomely for doing so. (Such plants have relatively low capital costs, but high running costs when running, so they need to make their money quickly).

The Merredin plant, however, is probably happy not to run. The structure of capacity markets have been criticised in both the US and European markets for providing unnecessary support to coal and gas generator that simply prolong their life.

Now, there is a push for some sort of capacity market to be introduced into Australia’s main grid – mostly by fossil fuel generation companies, of course. A much touted alternative is a “flexibility” market, which could also take in speed of response and emissions, and could encourage smarter and cleaner technologies like battery storage.

It’s a salutary lesson. W.A. authorities have since recognised that they might not have got the settings quite right when they designed the capacity markets. In fact, back in 2012 it was estimated that $200 million was being spent subsidising fossil fuel generators that waren’t needed at all.

It’s about to rewrite the market rules, as it prepares for a very different future, a transition to a grid that the market operator describes as “digital, democratised and distributed” with rooftop solar PV, battery storage, demand management and electric vehicles playing a key role. It remains to be seen what happens to the capacity market over the long term.

The owners of the Merredin plant were not pleased with recent proposed changes.

They wrote to AEMO in 2018 saying that the benchmark price for reserve capacity payments was too low, – it had fallen from around $180,000 when the plant was first built – and not enough to cause new generators to be built, and they complained to the regulator in 2017 about proposed changes to the capacity mechanisms, particularly proposed auctions of capacity that could reduce prices.

Things have now worked out pretty well for them. The auctions have not happened, and Palisade Investment Partners, which owns 46.7 per cent of the generator, said last month it had locked in new financing for $43 million of debt at “historic low” interest rates for the next 11 years from a facility led by ANZ.

This was thanks to “a favourable regulatory change implemented in February 2020 which provides a guaranteed revenue floor on reserve capacity pricing for Merredin until September 2031.”

Those changes lock in a minimum payment of $114,000/MW and a cap of $140,000/MW over the next 10 years. Which means that Merredin is guaranteed annual income of at least $9.4 million (and up to $11.5 million) – just for being there.

Who knows, it may one day be called into regular use. But if it doesn’t, and the payments extend to 2037 (the generator has a stated “life” of 25 years), then the company may pocket between $250 million and $300 million over the life of the plant.

“As a consequence of these changes, Merredin has been able to implement a fixed financing solution that removes future refinance risk from the business,” Palisade said. The balance of the Merredin power plant is held by Hoperidge Capital and its affiliates.




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