When the lights go out in bureaucrats brains

Public service guardians of the energy market seem to forget everything they love about markets as they push incumbent generators' argument that a renewable energy induced oversupply will somehow mean power blackouts.

There seems to be a great degree of consternation being expressed by some government officials and energy suppliers that the RET is a major problem because it will drive oversupply in our electricity market. This is an argument the Victorian Government is pushing in its submission to the RET Review.

I want to pose what I think is a simple question to you. First the context:

Fact 1: We currently have a collection of power stations in Australia which, on average, delivers us power with average emissions of about one tonne of CO2 per megawatt-hour. 

Fact 2: If we’d like to keep the risks of excessive global warming low then, according to the likes of the International Energy Agency, we need to get this down to about 0.1 tonnes of CO2 per megawatt-hour – and at the same time we need to keep growth in electricity consumption modest.

Fact 3: We need to do this within about three decades and power stations tend to have an operational life of 20-40 years.

Now the question:

With this context, and assuming the Coalition wants to achieve its climate change policy objectives, shouldn’t we be instituting policies where:

1) we now build power stations with emissions below 0.1 tCO2/MWh; and

2) that these will be built with the deliberate intention of creating excess generation capacity that then squeezes out supply from the existing high-polluting power stations?

Think about the alternative for a second - do we want to shut down coal power stations without having alternative supply already in place to replace them? 

Sometimes it seems like even experts' understanding of how the energy market functions goes out the window once they see some “greenie” thing overlaid on top of it.

They seem to have an emotionally indignant reaction to this “greenie” policy overlay, where they then seem to forget everything else they know about how markets tend to function and automatically self-adjust.

Such as:

– When demand is low and supply is high, then shortages become less likely and prices are more likely to remain low.

– And that if prices get too low, then supply should be rationally withdrawn and that this is not a sign the market isn’t working but rather a sign it is working.

– And if there are temporary periods where demand is very high and supply struggles to keep up, then prices will rise during this period, encouraging new supply to be built (or discouraging the withdrawal of existing capacity).

To illustrate this mode of thinking, the Victorian Government has issued a submission to the Renewable Energy Target review suggesting that the target be reduced and should also be opened to support gas-fired power generation. The reason, they argue, is because electricity demand growth is pretty much flat and so the extra renewables is leading to an oversupply of electricity which means ... there is a heightened risk there will be a shortage of electricity. 

Here’s what they said:

"DSDBI [Department of State Development, Business and Innovation] is concerned that the RET is driving reliable baseload capacity out of the NEM and replacing it with variable renewable energy generation ... it is an issue of being able to meet supply during times of critical peak demand.

"The NEM is currently compromised in its ability to bring forward investment in peaking generation capacity to deal with this issue because of factors such as the effect of the RET on wholesale electricity prices, the NEM market price cap and increasing wholesale gas prices."

OK, so let’s ponder this for a second. Extra renewables drives down wholesale prices on average over the year which then leads to some coal capacity shutting. Then during the high demand events there’s a risk the wind might not blow but the previous coal capacity won’t be there to meet that demand.

Sure this all makes sense, but wouldn’t that also mean that prices are very likely to be very high during these short demand peaks, too? And given prices can rise to extraordinary levels as high as $13,000 per MWh wouldn’t that then mean there’s a really strong incentive to build gas peakers anyway?

But is there still a problem because wholesale prices are really low for the non-critical price periods and gas prices are going up?  

Well, actually, this doesn’t really matter.

Firstly, if you take the time to trawl through Australian Energy Market Operator statistics you’ll find gas peakers have historically run quite infrequently – the average utilisation (or capacity factor) of Victorian gas peaking turbines over the period 2008-09 to 2012-13 is just 6 per cent. Because the construction cost of gas peakers is quite low they actually don't need to run all that often to be viable.

So the possibility that prices might be depressed for much of the year due to the RET doesn’t mean much to them, provided there are a few periods when prices are high. Indeed gas peakers can make money even if they didn’t run at all.  That’s because they are in the business of providing insurance as much as power, where they sell what are known as price cap contracts. Retailers buy these contracts to cover themselves just in case prices were to spike to very high levels, well above the prices they charge end consumers. If electricity retailers judge that wind and solar are unreliable during peak demand periods, then they’ll be keen to purchase price cap contracts from someone offering to build a new gas peaker.

Also, the gas price rising is not that big a deal in the overall scheme of things, once you consider power prices can rise as high as $13,000 per megawatt-hour. To explain, to generate a megawatt-hour of electricity a new gas peaker consumes approximately 10 gigajoules of gas. Wholesale gas prices could rise potentially by as much as $5 per gigajoule which increases a gas peaker’s costs by $50 MWh.

Fifty bucks versus $13,000 – are gas prices really going to be a barrier to a gas peaker's viability if it turns out we need more supply during peak periods?