EXPERT REACTION: AEMO warns of power shortfalls across five states

"From gas crisis in Europe to bankruptcies amongst electricity retailers in England and Singapore, the wind has blown the energy crisis south easterly to the east coast of Australia. It is not all about rising energy costs and coal maintenance outages in NSW and QLD.

Competition among generators is good as its meant to keep prices in check, but what happens if a few get together and simply refuse to bid? You have a big problem with blackouts becoming reality and not just threats. Some suburbs have suffered blackouts already in NSW but there is silence from AusGrid as to why. If AEMO must step in and beg generators, you have a major problem with the whole electricity regulatory and generation system.

Electricity or gas pricing traded on an open market is likely to undergo some strange pricing behaviour. The current crisis in NSW and Queensland is a mixture of maintenance issues at coal fired power stations (usually lasting about 2-3 months) and generators voluntarily not willing to supply electricity with electricity and gas prices capped at $300 megawatt hour and $40/GJ. 

It has nothing to do with SA or Vic having greater renewable capacity. The entire process around submission of bids from generators in the National Electricity Market (NEM) needs an overhaul. Given Australia is a powerhouse when it comes to coal and gas, we should not be having such a crisis despite high costs of coal and gas globally.

Take Saudi Arabia, rich in oil and therefore its citizens enjoy the cheapest petrol prices in the world. This should be the case also in Australia. We should not be under threat of blackouts and electricity prices going through the roof. This is also a great opportunity for customers to shop around and for energy brokers to start dialling their phones to make their cut and get switching commission from energy retailers.

While most of NSW and QLD were able to keep themselves warm overnight, this is a wakeup call that in addition to reliable baseload power we also need to have the spare reliable capacity to meet peak demand when there are maintenance issues."

The confluence of events starting from unexpectedly long outages (both planned and unplanned), unexpectedly long extended cold period is already quite problematic and leads to risk of outages. 

Combined with the shortage of natural gas on the global market trigger by sanctions against Russia this has caused a set of never before seen challenges for the Australian grid and electricity market frameworks. This would have been avoided if sufficient volumes of Australian natural gas were always available for domestic use in a way that decouples us from the international market which is now so tight there is essential no limit to the price being asked by uncontracted sellers.

This also could have been avoided if there was a consistent climate-energy policy for the last 10 years (including a proper price on carbon or similar) that would have incentivised the investment in infrastructure such as like storage and transmission to both underpin a faster renewable transition and prevent the vulnerability of the grid to external shocks. 

The complete Laissez Faire approach to both our natural resources (LNG) and market frameworks that assume all actors are rational and the market will sort it out have clearly failed us this week. A different approach is required.

We know that renewables are intermittent and their penetration is increasing in the grid, which could make the grid unreliable. To make them reliable, or to make them our base power, we need energy storage in addition to interconnectors. 

To move the grid to the places the power is needed, energy storage such as batteries could be one of the potential solutions.

“This crisis is due to multiple factors:

• aging coal infrastructure that is not being maintained by an industry ready to jettison unprofitable assets;

• a move to distributed generation (renewables) over the last 20 years that needs a completely different grid network with much larger interconnectors to allow electricity to be moved across state borders (between those that have too much renewable energy and those that don't);

• a previous Federal Government that had it's 'head in the sand' and didn't drive the grid infrastructure change;

• domestic gas prices spiking because of international supply issues (Ukraine war), whereby companies want to maximise profit by selling available gas to the highest bidder.

Australia has plenty of electricity, much it from renewables, but not where its needed because the grid has significant pinch-points (interconnectors).  The wind is still blowing the wind turbines and the sun is still shining on plenty of solar farms, and the dams are full in Tasmania and the Snowy Mountains, but the grid is not designed to move what is needed to those places the power is needed.

We had a decade of government inaction, and despite repeated warnings about the outcome, no one was prepared to listen. Until now.”

As we gradually transition into the renewables, it is very important that the baseload power stations are maintained regularly and well in advance of the peak power seasons with some kind of regulatory oversights applied. With proper planning and coordination, these sort of outages is preventable.

The current problems affecting the electricity market reflect:

• Significantly heightened international gas prices caused by the Ukraine conflict with disruptions of gas and oil supply into Western Europe through supply and demand embargos.
• Direct linkage between Australian domestic spot gas prices and heightened internationally traded gas prices following the establishment of LNG exports from Queensland which has had the effect of increasing the domestic gas price significantly over the short term.
• The general focus on gas export markets has meant that domestic gas users have had difficulty in obtaining longer term gas supply agreements, making them vulnerable to short term fluctuations (particularly increases) in domestic spot gas prices following increases in international traded gas prices.
• An unusually high amount of coal generator closures, both planned and unplanned.
• Unusually high morning and evening winter peak demands associated with the recent cold snap.
• An administered price cap of $300/MWh was implemented by the Australian Energy Market Operator (AEMO) initially in Queensland but then shortly followed in New South Wales, Victoria and South Australia in response to a sustained run of high wholesale electricity prices occurring over the last several days.
• The withdrawal of gas generation capacity in response to the recently introduced administered cap price which was below the price they needed to break even given the current high domestic spot price of gas.
• AEMO subsequently used its powers under the National Electricity Law to direct previously withdrawn gas plant to commence generating electricity to balance high morning and evening peak demands as well as covering the possibility of unexpected outage of operational generators or network infrastructure.

The current energy crisis is clearly at the forefront of many people's minds.  Households bear the weight of higher prices, manufacturers even more so, market observers have never been so busy and politicians, as ever, are busy apportioning blame and looking for an easy fix.  There certainly is plenty of blame to go around, and just as certainly, there is no easy fix.

How exactly it has come to this will no doubt be studied in careful details by energy economists, and such a post-mortem analysis will be very useful.  At this point though, two things are certain in spite of much misplaced commentary.  First, the market actually does work.  Yes, prices are high – more on this in a minute – but as of writing, anyone demanding energy received energy.  High prices may be uncomfortable to some, but they are not a symptom of market failure.  There has been no involuntary curtailment.  Some retailers, like the famed ReAmped have had to close shop or shed customers, typically because of poor risk management, but then there never was a guarantee from either taxpayers nor consumers that they should continue to exist no matter what, especially if they engage in poor business practices.  

Second, and a clear consequence of the absence of market failure, the much talked-about capacity mechanism is not the solution one needs to mitigate such a crisis.  With too-broad a brush, a capacity mechanism involves payments to generators just to be present, with sometimes a loose promise to operate as required.  Most capacity mechanisms are very costly to consumers, and no capacity mechanism can address the supply problem we currently face.  As of writing, approximately 20% of the capacity of coal-fired generators is offline -- by choice.  If the large generators were operating, as they should, there would be ample supply; we would observe higher prices than normal, but not the ones currently seen. In other words, there is no capacity shortage at present in Australia – so what would a capacity mechanism solve? In fact, if we had a capacity mechanism in place today, we would still have no guarantee of enhanced supply. Why? Simply because generators are better off curtailing supply, and no capacity mechanism comes with stick large enough to compel supply. 

Why are generators better off not supplying? Here too there are two reasons: one, their input costs have increased manyfold (unless they were properly hedged); the best response to such an increase in marginal cost is to decrease quantities to raise prices.  The best way to restrict quantities is to let a fraction of one’s fleet go offline; once offline, AEMO cannot compel supply. Hence, we get to the meat of it: why do we even allow so many generators to enter unplanned outages for days on end? Short of an explosion, what is so urgent that cannot wait for a week or two?  
Two, the long-run effect of these sustained high prices is the disappearance of smaller, stand-alone retailers.  It is that much less competition for the gentailers, which control ¾ of the capacity, on the retail side.  The impact of this long-standing vertical integration is that they win both ways.

This episode is not an instance of market failure.  Rather, it is a regulatory failure.  The regulatory shortcomings of the NEM are many.  The salient point is today is that a capacity mechanism solves none of problems we face.

The current crisis illustrates two things:
1.    The need to invest more rapidly to remove our dependence on fossil fuel supply chains and centralised fossil generation by switching to a more distributed 100% renewable energy system
2.    The opportunity wasted over the last decade to advance the energy transition through Federal inaction on climate change.

Addressing this in the short and long term will not be easy, and significant investment in research will be needed to find an holistic solution to our total energy needs.  This will be based primarily around long-term electrification with a doubling or tripling of the domestic electricity sector, including efficient conversion to heat and hydrogen across the entire economy.  However, if we are to maintain the nation’s wealth creation as an energy exporting nation, then the investment in future renewable electricity export systems will potentially be many times greater than this.  In the meantime, market redesign to minimise the shortcomings of fossil fuel generation in the electricity market and to accelerate their exit will be needed to smooth the transition to renewables.

Australia's current energy crisis is one of its own making. Following over 10 years of divisive and incoherent energy policy, the electricity market is showing the strain of ineffectual policy incentives. The focus of our attention now should be on the rapid expansion of renewable energy and a range of storage options that will provide greater certainty for energy users.

The current electricity market design is no longer fit for purpose and will make the transition to clean energy far more difficult for our society as a whole. With spiralling wholesale market costs, we are likely to have to endure greater costs for energy.

The security of supply of electricity is paramount to maintaining our modern society and without it, we will endure severe economic consequences. In the coming months we are likely to see increasing electricity costs which will compound the issues we currently face from petrol and diesel prices. Supply chain risks, food prices and more generally costs of living will be further exacerbated in the coming weeks/months due to poorly executed and incoherent energy policies.

Electricity prices are elevated as energy use rises due to cold weather and as east coast coal production outages continue. Price caps on electricity mean that generators may be operating at a loss and are therefore not incentivised to keep output going. Natural gas, which is a substitute for coal in electricity generation, is itself in short supply as Asia’s demand for Australian gas rises – some Asian nations are experiencing shortages on account of Russian gas bans.

Short-term relief for the electricity market may only arrive when the nation’s offline coal plants make a comeback, and if weather improves. Later in the year, new gas and LNG projects are expected from most of the major producing regions, such as the US and Middle East, which should put downward price pressure on gas and consequently electricity.