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Josh Frydenberg - Liberal for Kooyong
  
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How we are fixing Australia's energy market

Date: Monday, 9 October 2017 9:00 AM
Location: The AFR National Energy Summit 2017

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Just the other day, I got a call from the owner of my local IGA. It’s where my family shop on a weekly basis.

His energy bill had increased by almost 100 per cent year on year and he was in despair. 

The cost increase was the equivalent of a fulltime shelf packer. And given the already tight margins and competitive grocery market, his only choice was to reassess his staffing requirements.

This story is far from unique – but is repeated every day across every business sector in our economy.

Complexity of energy policy is no longer an academic issue fought out between regulators and big energy companies, but rather is now a barbecue stopper with everyone looking for answers.

So today, I would like to respond to these concerns by addressing three particular points.

Firstly, an honest appraisal of where we are.

Secondly, how we got here.

And thirdly, most importantly, where are we going and the principles that are driving our plan to get there.

Our energy market today

Australia’s electricity prices are high by international standards. 

A decade ago under John Howard, they were the fifth lowest in the OECD, but as of the IEA’s 2017 energy report, released in August, we have climbed thirteen spots to the twelfeth highest, thanks to a rapid price increase not seen by many other OECD countries.

It’s a ladder you don’t want to be climbing. Particularly as it hits our lowest income households the hardest, as the bottom 20 per cent spend as a proportion five times more of their disposable income on electricity than the highest 20 per cent.

The resilience of our network has also weakened, with load-shedding and blackouts in South Australia and significant stress at peak demand in both New South Wales and Victoria earlier this year.

When it comes to emissions in the electricity sector, they have fallen over the last two quarters as the consequence of the closure of coal-fired power stations and flat-lining demand.

However, this transition to lower emissions cannot come at the expense of the reliability and affordability of our electricity system.

As Minister for both Energy and Environment, the first time these responsibilities have been brought together, I am acutely aware of this delicate balance.

Should reliability and affordability be compromised, public support for tackling climate change will quickly diminish and previous gains lost.

This is in nobody’s interest.

The reality we must now face is that the National Electricity Market, which began in 1998 and served us well for nearly 20 years, is now no longer doing so.

Historically, we had surplus capacity, steadily rising demand, overwhelmingly synchronous generation and everybody was on the grid.

Today, the surplus has been eroded with ten coal-fired power stations closing since the start of the decade, taking 5,900 MW or more than 10 per cent of capacity out of the NEM. While it’s not like for like, there has been 3,230 MW of new intermittent generation added to the grid over the last 10 years and more than 5,000 MW of solar PV – millions of Australians are making an economic and environmental choice to reduce their dependence on the grid. 

The result is that supply and demand is now much harder to predict and a pricing and despatch model, which was predicated on marginal cost bidding by generators, is less suited to the times.

This is because in an energy only market, large amounts of wind and solar produce low wholesale prices when they are running, but very high prices when they are not.

This volatility creates an uncertain investment climate and makes it more difficult for synchronous generators to recover their fixed costs and remain commercially viable.

As these generators are pushed out, liquidity in the contract market is reduced, not only because there are fewer participants who can provide firm hedging, but also because new entrants are deterred by the greater volatility risk.

To take this point to the extreme, the Grattan Institute has pointed out that, for a system with 100 per cent renewables, the wholesale price cap would need to lift more than fivefold to between $60,000 and $80,000 to ensure a sufficient revenue stream.

No jurisdiction could be expected to embrace such extremes and in many other countries they have not.

The causes of the pressures on the NEM, however, go beyond the changing market dynamic to something more structural.

While it adopts the term “national”, there are many important elements that are clearly not so.

The ownership of many of the networks and the reliability standards under which they operate are in the hands of the states: Victoria has its own set of rules for consumer protection in its retail system; government-owned generators in Queensland produce more than 60 per cent of the power; states and territories own and regulate their gas and coal resources under the ground; and when it comes to renewable energy targets, nearly every state has a different number, date and method by which to achieve it.

To say our system is balkanised would not be far from the truth.

It also helps explain why achieving national consistency and coherency in energy policy has eluded previous federal and state administrations regardless of their political persuasion.

It’s high time that the states and territories accepted that by going it alone and frustrating a truly national approach, they are driving prices higher, reliability lower and making the smooth transition to a lower emissions future that much more difficult.

By sanctioning the uncompetitive bidding practices of government-owned generators or appeals under the Merits Review process for networks, state governments have prioritised profits over lower energy prices.

Indeed in Queensland over the last few months, the wholesale electricity prices have gone down by 25 per cent, following a belated state ministerial direction.

And in the ACT and New South Wales had the Limited Merits Review process been abolished sooner, citizens of those jurisdictions would have had power bill savings of more than $5 billion.

In fact, network pricing more generally has been a big problem, contributing 41 per cent to electricity price increases since 2008, according to the ACCC.

While we have seen the rates of return for networks reduce from more than ten per cent between 2008 and 2010 to around six per cent today, the growing regulated asset base is still a problem.

Between 2006 and 2016, when demand was falling, the asset base for networks increased remarkably from $37 billion to $84 billion.

A lower rate of return on such a big number is still a big number.

Standards set by state governments, particularly in Queensland and New South Wales, bear a lot of the blame for these increases.

Energy Networks Australia estimates that $11 billion of grid infrastructure is used only around 1 per cent of the time (4-5 days per year), therefore the key to reducing network costs into the future is to create a more efficient system to reduce peak demand.

To do so, demand side response supported by cost reflective tariffs that move from a volume weighted cost to a time weighted cost will be important. The end result will be more equitable and lower cost.

Likewise, by restricting gas developments and legislating their own renewable energy targets, the states and territories are putting politics and ideology not just ahead of lower energy prices, but also in both instances going against the expressed recommendations of the Chief Scientist Alan Finkel in his review for the COAG Leaders.

Gas-powered generation is increasingly important to the electricity sector as coal plants have closed, not just in terms of providing supply, but also critical stability services.

Just two years ago, gas was setting prices across the NEM 13 per cent of the time. But this year, gas is setting NEM prices 23 per cent of the time. In the same period, the east coast states’ average wholesale spot price went from $3.50 per GJ to slightly over $9 a GJ.  

As a result, electricity is 70 per cent more expensive when gas sets the NEM price, which contributes to higher electricity prices overall. The reliance on gas is particularly a problem in South Australia as AEMO has been forced to instruct the gas generators to come online more often.

For example, on one occasion recently this was because of insufficient wind supply and on another occasion it was when more than enough wind was blowing, but the system lacked the necessary FCAS and inertia services. 

We clearly need more gas supply and Australia has got it. 

Given the states are sitting on decades’ worth of resource, it is simply not good enough to outsource their responsibilities to Canberra to restrict exports, while relying on Queensland to produce more than 99 per cent of the east coast unconventional gas supply.

By relying on Queensland to do the heavy lifting, the southern states are forcing unnecessary scarcity onto consumers and increasing wholesale gas prices by up to 25 per cent, which is the cost of transportation from up north.

There is no doubt too that a decade long failure in Australia to effectively integrate climate and energy policy has created uncertainty in the market impacting investment decisions, pricing and reliability.

This failure is not an orphan. 

Although as ACCC Chairman Rod Sims rightly pointed out to the National Press Club recently, this is not “the sole reason for our current electricity affordability problem” as often conveniently claimed by some industry players.

We must also acknowledge that emissions reductions policy can come at a financial cost and even those policies that have attracted bipartisan support have been far from perfect.

Case in point is the Renewable Energy Target which was clearly industry policy designed to pull through renewable technologies. 

However, this policy did not anticipate or adequately deal with the situation where there would be a particularly high penetration of renewable in a single region, namely South Australia, where storage and stability services would be at a premium.

Until Prime Minister Turnbull put renewable energy storage at the top of the policy agenda, this piece of the puzzle had been missing.

While renewable energy advocates quickly seek to justify their subsidies by pointing to emissions as a costly externality it is only fair to point out that renewables without storage are also a costly burden.

The best illustration is the experience of South Australia, where the spot price increased by 84 per cent between 2015-16 and 2016-17, following the closure of the Northern coal-fired power station last May and the rising cost of gas-fired generation.

With wind on any given day providing between zero and 100 per cent plus of the state’s needs and only limited and more expensive gas left to balance the variability, the markets quickly priced in this risk.

It is in this brave new world of a radically changing energy mix, disruptive technology and the empowerment of consumers who are no longer at the end of the supply chain but rather in the middle that the Turnbull Government is implementing its energy plan.

It is challenging but possible to simultaneously put downward pressure on prices and enhance the reliability of the system, while meeting our international emissions reduction targets.

The need for better regulated markets, more transparency and competition

The principles that guide our plan and actions include faith in well-regulated markets and an abiding commitment to innovation and harnessing new technology to the benefit of the consumer.

When it comes to the current regulatory system, unfortunately the rules have not kept pace with real world developments, which is impacting on affordability. 

This is why we acted to abolish the Limited Merits Review process and increase by more than $67 million the funding to the independent regulator, the AER.

That is why we also called in the retailers and agreed with them a wide range of changes to boost transparency and provide comparable and timely information in plain English to customers so that they can access the best priced deals.

In the last eight weeks nearly half a million people have accessed the Government’s Energy Made Easy website (to compare retail offers), indicative of the traction that these reforms are already having.

This is why we’ve also implemented the most significant reforms to gas pipeline markets in more than two decades, introducing compulsory arbitration in the absence of an agreement between pipeliners and producers.

While also establishing gas bulletin boards that indicate a visible price index to customers and introducing a secondary market for trading spare pipeline capacity.

In each instance, whether it be with network, retailers or pipelines, we are seeking to strengthen the hand of consumers where there is monopoly or oligopoly pricing behaviour.

There is more to be done. The ACCC has outlined its concern with market concentration, particularly in the wholesale electricity market.

In each region of the NEM, the two or three biggest generators between them control more than 70 per cent of capacity and dispatched energy.

This has been increasing over time.

As an illustration, the big three, AGL, EnergyAustralia and Origin between them in 2009 had 15 per cent of generation capacity in the NEM. Today, it’s nearly 50 per cent.

This concentration can affect bidding behaviour as the companies know that their market dominance guarantees dispatch regardless of price.

This is why I have asked the AER to investigate bidding practices by generators with a particular focus on New South Wales.

I look forward to receiving their initial findings in November.

While this type of behaviour may technically be within the NEM rules, it is not in the long-term interests of consumers.

Governments will need to consider what rule changes may be required.

The need for a great emphasis on reliability

Another area where the current market design needs reform is around reliability.

The Turnbull Government is acutely aware of Alan Finkel’s warning, “existing wholesale and contract market investment signals are no longer a suitably dependable mechanism to ensure the reliability of the grid.”

AEMO has made similar statements.

This is because following the closure of Hazelwood and Northern, wholesale price volatility has increased enormously.

For example, in South Australia, the number of price events above $200 a megawatt hour or below negative $100 dollars a megawatt hour (which is due to the intermittency of wind generation) have increased by 400 per cent in just the last two years.

It is against this backdrop that the Turnbull Government commissioned AEMO to provide advice on the adequacy of existing and future dispatchable resources and what action could be taken to address any shortfall.

The response was unequivocal. Strategic reserves as recommended by Finkel are needed in the short-term, together with an appreciation that the closure of Liddell, scheduled for 2022, would leave a shortfall of 1,000 megawatts of dispatchable capacity.

In the longer-term, the solution AEMO suggest could be provided by a yet-to-be-specified extended market design change.

This could also include, according to AEMO, “demand-side markets, day-ahead commitments, the articulation of a generator reliability obligation and further approaches to gaining investment in flexible capacity.”

It was AEMO’s conclusion about the potential shortfalls that drove our conversations with AGL about Liddell.

The same is true for our decision to put in place the ADGSM and our subsequent agreement with the gas exporters. AEMO and ACCC’s advice about the gas shortfall in 2018 and 2019 was clear.

Our quick and effective response is in stark contrast to Labor’s refusal and failure to act back in 2012, when they were advised in government by AEMO and in their own energy white paper that the expansion of the east coast gas export market would have a detrimental impact on domestic gas supply and prices.

In reaffirming our confidence in markets, it’s very important to reject the claim that it has been the privatisation of assets in South Australia and Victoria that has led to the energy challenges those states face.

As we have seen in Queensland and New South Wales, government ownership of generation and network assets is no guarantor of lower prices or better reliability.

The key is having an effective regulatory framework with a real emphasis on transparency and competition.

New technology and the declining cost curve

The second key principle is the Coalition’s commitment to innovation and the harnessing of new technology.

Just as the mobile phone disrupted the landline and the digital camera superseded film, the energy market is being shaped by the so-called internet-of-things; behind-the-meter technology such as solar PV and storage; demand-side responses; and increasingly cost effective utility scale renewable generation.

Globally in the past seven years, the cost of wind-powered generation has more than halved. Domestially, solar PV costs have dropped more than 50 per cent.

Similar cost reductions in Australia have been supported by cumulative commitments of more than $4.3 billion by the CEFC to projects worth over $11 billion (as at 30 June 2017), and over $1 billion in ARENA commitments matched by more than $2.5 billion in co-funding (as at 30 June 2017).  

By 2020, costs of battery technologies are expected to fall 40 to 60 per cent and over 70 per cent to 2030. 

A good illustration is the recently announced deal involving the 530 MW Stockyard Hill Wind Farm near Ballarat in Victoria, which saw a new benchmark of less than $60 MWh, which included the generators signing away the LGCs.

Households who have made clear their intentions with solar PV are now also entering the battery storage market. The number of household batteries installed is expected to reach over 100,000 systems by 2020, and nearly 1 million by 2030.

Australians too are at the forefront of the global research and development effort, with the University of New South Wales home to a world record number of solar cell technology breakthroughs.

The Turnbull Government is funding the expansion of pumped hydro facilities, with positive results revealed last week with the feasibility study at Cultana in South Australia, which could see it become the only saltwater facility of its kind in the world.

And Snowy Hydro 2.0, which when complete, will be the battery of the east coast and the largest such pumped hydro project in the southern hemisphere.

There is a real alignment here between the Government’s focus on technology and in particular storage and the evolving regulatory framework.

AEMO’s emphasis on dispatchability, demand-side response both at the commercial and household level and the recent decision to move over time to five minute as opposed to 30 minute settlement periods will all incentivise the most cost effective new technologies.

It is against this backdrop of a declining cost curve for renewables and storage, greater efficiencies that can be found in thermal generation and the need for sufficient dispatchable power in the system that we are considering the Finkel Review’s 50th recommendation to which we’ll respond before the end of the year.

It is important to not lose sight of the fact that we accepted and are now implementing 49 out of the 50 Finkel recommendations through the COAG Energy Council. Many of the recommendations will have a profound impact, with new requirements around notice of closure, generator reliability and security being long overdue.

Conclusion

It’s a well-worn aphorism that it often takes longer to fix problems than to create them.

However, with respect to Australia’s energy policy, we all must ensure that this is not the case.

As these problems have been building for more than a decade and the clock is ticking for them to be resolved.

Our approach in government has been and will be to seek out the best advice from the expert market bodies and use that input to frame our actions.

Whether it be based on the Finkel Review or advice from AEMO, AEMC, the AER and the ACCC, the Government is implementing comprehensive energy policy reforms which place an emphasis on well-regulated markets and technology-led innovation.

It is this combination that will deliver affordable reliable and lower emissions energy outcomes for all consumers and the necessary $200 billion in infrastructure investment the market will require between now and 2050.

The actions we are taking cover gas supply, wholesale market structures, integrated energy and climate policy, network regulation and retail competition, and address both the immediate priorities as well as preparing for the long term.

We intend to work with the states and territories to deliver our plan.

If energy policy was easy it wouldn’t be the barbeque stopper it is today. But the good news is we have learned the lessons from the past, we know where we are going and we have a comprehensive plan to get there.

Josh Frydenberg is the Federal Minister for the Environment and Energy.

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