How MacGen could pollute AGL's attitude

Bids are due from ERM and AGL on Wednesday for the NSW government-owned Macquarie Generation, or ‘MacGen’.

MacGen is comprised of two large coal-fired generators: the 2640 MW Bayswater and 2000 MW Liddell, plus a small 50 MW gas peaker. Together their capacity represents 38 per cent of NSW peak demand and 28 per cent of total NSW installed generation capacity.

The ACCC is yet to indicate whether it has any issues with AGL purchasing all or part of MacGen’s power stations. However, for many prospective new entrant generators, which are mainly in solar and wind, and large electricity consumers, there will be considerable concerns about AGL’s bid succeeding.

For consumers, concerns largely focus on the fact that AGL already possesses a substantial share of generating capacity in Victoria and South Australia. During periods of high electricity demand, prices are extremely sensitive to withdrawals of capacity. Prices can move from $50 per megawatt-hour to above $10,000 per MWh within the space of minutes if even just a fraction of a major coal or gas generator’s capacity is withdrawn or, as is often the case, offered into the market at an astronomical price well above what they normally require.

This is because electricity is a non-storable commodity and there is minimal capacity for consumption to shift in time or place at short notice. 

By comparison, if you went into the local Coles and they had suddenly increased prices on Weet-Bix to $100 per packet, you’d either 1) buy some other cereal or 2) delay the purchase until you have the time to visit another competing supermarket.

In South Australia AGL has 36 per cent share of the generating market and has been repeatedly accused of manipulating prices in that state. The Australian Energy Regulator in its 2012 State of the Energy Market report observed:

In 2012 AGL lifted its stake in the Victoria’s largest generator – 2180MW Loy Yang A – to 100 per cent which boosted its share of Victoria’s total generation market from 8 per cent to a far more hefty 27 per cent. Strangely this was passed through by the ACCC without objection, when in 2004 they had attempted, unsuccessfully, to block AGL from taking just a third share of the generator, arguing it would substantially lessen competition. The ACCC’s earlier attempt to block AGL was stymied by a Federal Court ruling that deemed Loy Yang A was subject to competition not only from Victorian generators but also generators interstate, notably NSW black coal generators.

But now it’s possible that with the acquisition of MacGen, AGL could have its hands on over a quarter of the generation across South Australia, Victoria and NSW. This makes an argument about interstate competition constraining market power, for which a number of analysts believe the Federal Court justice was duped about anyway, rather hard to maintain.  

Yet, in the end, MacGen already has the proven ability to manipulate prices in NSW. 

Indeed the former chief executive of MacGen, Russell Skelton, admitted as much to The Australian Financial Review in February 2012. The paper reported that he told them that to restore profitability with the introduction of the carbon tax, just like any good monopolist, the generator would aim to push up market prices by withholding a proportion of its capacity. Then, to back up his threat, he made the incredible admission that, “we have done it in the past to respond to varying market circumstances”.

MacGen’s market power is well understood within electricity market circles. The Australian Energy Regulator has noted that constraints on the interconnector with Victoria have allowed MacGen to substantially increase prices by bidding in large chunks of its capacity at very high prices well above its costs. Energy consumer advocates and market analysts David Headberry and Bob Lim have also backed up Skelton’s threat, noting that records show the company has spiked prices through withholding capacity on multiple occasions before and since a particularly overt incident in 2007.

Ideally in the interests of a competitive electricity market, NSW should have split MacGen some time ago but, of course, this was counter to the interests of the NSW Treasury.

However, in spite of such evidence the Australian Energy Market Commission has said that it believes the evidence of withholding of capacity is nothing to be too concerned about. Overall, wholesale market prices across the NEM have remained on average below the long-run costs of new generation. This suggests that even if generators are gaming the market, they aren’t horribly gouging consumers. Supporting its case that there is little to worry about, the AEMC stated:

“In more recent years there have been developments in the wholesale market that make the exercise of substantial market power unlikely, in particular falling demand and a greater uptake of wind generation.”

Supporting this observation was that the AER had noted South Australian prices have become less volatile in recent years after price spikes it accused AGL of inducing. The AER noted:

Wind generators bid low and sometimes slightly negative prices, given they earn the value of renewable energy certificates (in addition to spot market returns) to cover costs. For this reason, South Australian wind generation is contributing to lower spot prices for the state.

But this is where an acquisition of MacGen by AGL becomes particularly concerning. 

To finance new wind generation projects, developers are heavily dependent on the three dominant east coast electricity retailers of Origin Energy, Energy Australia and AGL providing long-term power purchase agreements. This is only done because the retailers need to meet legal obligations under the Renewable Energy Target or face a penalty.  

Both Origin and Energy Australia have been furiously lobbying to have the Renewable Energy Target watered-down, with AGL the notable exception. 

Given AGL’s strong presence as an electricity generator and retailer, it’s stance in favour of the RET has lent considerable credibility to defenders of the scheme, and undermined arguments from Origin and Energy Australia that the target was unrealistic and unachievable.

The 2012 acquisition of the remaining stake in Loy Yang A meant AGL’s commercial interests shifted more towards those of Origin and Energy Australia. If it were to acquire MacGen then it would seem almost impossible to justify to shareholders why it publicly backs a policy that supports the entry of thousands of megawatts of low-bidding competition, which depresses prices and steals volume from its newly acquired coal generators.