Guest Post: The Australian Energy Market

By Ben Skinner and Carol Tran Australian Energy Council

Discussion about the emergence of a new energy market dynamic and whether there is a need to address it, has recently developed in the public arena.

There has been significant attention on negative price events in the National Electricity Market (NEM) and the potential impact on the business model of traditional generators.

Most recently, the Australian Energy Market Operator (AEMO) flagged the need to consider market rule changes to recognise the types of resources and “usefulness”, or dispatchability, of generation needed to run the electricity grid. And the chair of the Energy Security Board (ESB), Kerry Schott, also entered the public discussion earlier this week.

At a broader level, the ESB has released its issues paper on the post-2025 market design, which also considers what range of approaches might be needed to integrate higher proportions of renewable generation into the NEM.

So what is it all about?

Energy markets around the world fall broadly into two categories:

  • “Energy-only” markets such as the NEM, where generators receive the value for their production of energy and the capacity to provide it from the one energy price; and,
  • “Energy and Capacity markets” such as the WA’s Wholesale Electricity Market (WEM), where generators receive a return for their capacity from one revenue stream and another for their efficient production of energy.

There is a common misconception, possibly arising from these simple terms, that in energy-only markets all generators are paid the same for all the electrons they produce. That would certainly be problematic as different generators have very different strengths and weaknesses: gas, coal, hydro, wind and solar. And even within technology classes, some generators are more dependable than others. Fortunately the market inherently recognises this, and certainly does not pay equal reward for unequal service. Yes, it pays generators the same price, but only at the location and time they are generating.

Time is the critical matter here. Customers will want a lot more electricity on a hot February evening than they would at noon on Good Friday. Reflecting that, prices are completely different at those two times. The market will pay a generator that is capable of running on a hot summer’s night many times more than one that is only capable of running at other times.

Generators are not equally useful, nor are they equally paid

These effects can be observed in the following data. Different technologies have received considerably different weighted average payments due to the times that they are running. Those that respond to the needs of the system tend to receive a premium to the simple time-weighted average, whilst those that tend to generate most at times of surplus tend to receive a discount.

Table 1: Premiums and discounts to the average spot price received by South Australian technologies in FY2018-19 (Colour code: Red: lower price / Green: premium price compared to average spot price). Source: Australian Energy Council’s Analysis

Note how in South Australia peaking plants (OCGT) tend to receive 13 multiples of the average price (see table 1). That is fair enough, they are coming on only at those times when the system needs them the most. And, by making profits at those brief times, they can go some way to covering their costs of remaining available to provide critical capacity to customers.

At the same time note how South Australian wind generation is earning 24 per cent less than the average. This can also be easily explained: Because wind is now so common in South Australia, when the wind blows hard there will be excess supply and prices will be low and sometimes negative. That is also fair enough – there is certainly value in their produced energy which avoids having to burn fossil fuels, but its value is less than other sources because of its intermittency and self-correlation. This is also a signal that wind developers will be taking into account – as the effect grows they will consider developing elsewhere where the effect is less severe.

The difference in prices received by different technologies are shown below for the past 10 years. The picture has changed as the supply mix has changed, note how the SA wind discount has progressively grown, although it eased somewhat in 2017-18 after transmission expansion allowed more surpluses to be exported. Recent system security restrictions on very high regional wind outputs would have also lessened the effect.

At the same time the NSW wind discount remains less severe as that technology has a lower relative penetration in that region, so there is a lower impact from its self-correlated output.

Table 2: Premiums and discounts to the average spot price received by technologies over the past ten financial years

(Colour code: Red: lower price / Green: premium price compared to average spot price) / Source: Australian Energy Council analysis

The price cap and the contract market

A key factor in the NEM’s favour is its very high price cap of $14,700/MWh. This is crucial as a lower price cap would cruel the livelihood of those generators providing the firm capacity that is so critical to meet customers’ demands of supply continuity. Many other electricity markets, due to political concerns, do not enjoy such a freedom and have no choice but to find another way to pay for this firm capacity.

The data presented here broadly shows how the energy-only market pays differently for different service, but it is only the “spot” market settled by AEMO. Behind these charts is another market – the “contract” market where generators and retailers hedge these spot prices over time. Whilst incomes from the contract market broadly follow these spot market figures, the contract market can also provide some generators an additional premium thanks to their ability to transfer risks from retailers. In return for protecting retailers from the most extreme prices, a hedge contract is worth both the expected spot price plus a premium for removing extreme outliers – a kind of insurance value. The net result is that the premiums received by the firmer generation technologies in the contract market are somewhat higher again than those presented here from the spot market.

Conclusion

The NEM’s energy-only market certainly attempts to recognise and reward generators for providing the firm capacity that customers need.

But this market design is not necessarily the long-term answer for the NEM. In it, investors are heavily exposed to the market’s swings and roundabouts, including those created through various distortions, such as subsidised competition and changes to government policy. Unfortunately there is no sign of these distortions and uncertainties ending anytime soon.

For these reasons the ESB is reviewing this design. They may well conclude in favour of a design that exposes investors less to those distortions and provides stakeholders more confidence in how long-term supply will be delivered.

But such a conclusion would not be a repudiation of the academic basis of the energy-only market. Instead it would be a pragmatic reflection that its academic perfection may not sit easily within an extremely imperfect investor environment.

 

This entry was posted in Uncategorized. Bookmark the permalink.

26 Responses to Guest Post: The Australian Energy Market

  1. stackja

    Subsidies distorting the market?
    Probably.
    Make all energy production equal.

  2. Rafe Champion

    Have any of the architects of this system been asked to explain why we got into wind and solar without storage?

  3. Dr Fred Lenin

    Get the pollie idiots the hell outof energy, messing about ,they know bugger all and stuff everything they lay their theivinghands on . Prorogue our parliaments for a few years ,on unpaid leave . They can hold conferences and lie till they are blue in the face to each other, place a strict ban on media coverage of the bullshit , remove all subsidies from scam energy and let the market sort it out .
    Western politics is stuffed we need to sweep it away and replace it with real democracy ,not thepretend crap they spout today.

  4. RobK

    Conclusion: the high spot market prices, capped at $14,700/MWh is a leg up for expensive add-ons such as batteries and synchronous condensers to gouge prices when buffering variable production .
    No mention is made of the fact that erratic RE presents itself to the baseload grid as a massive variable load bobbing up anywhere there is a drop in wind or some clouds momentarily shading the sun. RE makes life harder for baseload “ valuable “ energy and complicates the transmission infrastructure, increasing costs.
    Pre RE, predicting load on any part the grid was pretty straight forward and accurate. Those days are going, going, gone. Design specs have to be overhauled.(such as increased “ride through”of frequency excursions to accommodate wind farms, this has implications for other parts of the grid).
    It’s not just about spot price supply and demand but the cost of the total grid enabled to handle these vague opportunists…..with their parasitic subsidies.

  5. RobK

    Proponents of RE say they need more certainty of policy but RE has no certainty of production on any given time scale from sub seconds to years, it relies on penalising baseload with taxing energy certificates as subsidies . It really is the baseload generators that have been diddled by this scheme and the suggested alternative is an expensive experiment that has obvious short commings.

  6. Rafe Champion

    Amazing story of the botched deregulation of power prices in Alberta (Canada) that sacrificed the cheap “heritage” supply from high quality coal and put power prices at the mercy of the escalating gas prices.

  7. Ivan Denisovich

    No mention is made of the fact that erratic RE presents itself to the baseload grid as a massive variable load bobbing up anywhere there is a drop in wind or some clouds momentarily shading the sun. RE makes life harder for baseload “ valuable “ energy and complicates the transmission infrastructure, increasing costs.

    Patrick Byrne:

    It cited South Australia, where the electricity power price, set in 30-minute intervals, fell below zero for 9.9 per cent of the month of August, while the average prices in the March quarter soared to $154 per MW/h, just slightly lower than Victoria’s.

    These fluctuations play havoc with the viability of base-load coal-fired power stations, which rely on stable demand to supply low-cost power to the grid. Thus coal-fired power stations effectively subsidise renewables through the renewable energy target, which obliges base-load power stations to buy Renewable Energy Certificates produced by wind and solar farms and rooftop solar units. (More­over, they also have to pay coal royalties to the states.)

    This is effectively another tax on base-load power and a further subsidy for renewables, which dispels the myth that renewables provide cheaper power than fossil-fuel power stations.

    According to the Australian Energy Market Operator (AEMO), electricity prices in August in the eastern states rose to $84 a MW/h, a rise of 12 per cent from June, despite lower demand. AEMO gave no reason to explain why the price rose even as demand fell.

    An even more alarming picture emerges when one looks at forward price contracts for electricity, which reflect what large companies expect to pay in the future.

    The Financial Review said: “Forward prices are now 29 per cent higher than a year ago, averaging $94 per MW/h, defying forecasts that wholesale prices are set to soften.”

    Although federal Energy Minister Angus Taylor has set a target of $70 per MW/h by the end of 2021, forward prices for the March-2020 quarter in Victoria have reached $158.50 per MW/h, reflecting deep disquiet about the impact of renewables.

    One of Australia’s largest energy utilities, Energy Australia, which owns the Yallourn Power Station in the Latrobe Valley, has warned that the power station may be forced to close because its operations are becoming uneconomic.

    http://www.newsweekly.com.au/nwmobile/article.php?id=58700

  8. RobK

    NEM spot price bidding: the highest bid sets the price for all bids. Nice work if you can get it.

  9. Rex Mango

    The National Energy Market makes playing craps at the casino, or backing winners on the race track seem really simple. There would be no possible way for anyone to game this system.

  10. I_am_not_a_robot

    When Edison formed the Edison Illuminating Company some investors thought he had a good idea so did customers who then entered into agreements with the company to supply them with electricity.
    One hundred and forty years on, for crying out loud, we have AEMO, ESB, NEM, WEM, OCGT — the whole f-f-f-flamin’ think is a f-f-f-flippin’ mess.

  11. Herodotus

    This isn’t really that complicated.
    If you can’t offer affordable power 24/7 fuck off.

  12. Overburdened

    What I got from looking at the charts is that wind and solar are factored in to the shape of the market.

    The penetration rates of wind and solar would appear to be bordering on irrelevant.

    Naturally it’s a thing now, so the boffins will eventually make it work, and I suspect people will quickly adapt to reduced service.

  13. Texas Jack

    Leading libertarian blog? Newsflash from the trading floor team – in free markets prices can go anywhere.
    A N Y W H E R E …….
    All this whining about high prices is crud. They might be higher than grandma would like and higher than they were in 1974, but they’re neither high nor low. They simply are what they are given the forces you libertarians embrace. Speculators speculate. Exploiters exploit. Which, after thirty years actually speculating for a living, makes me realise that if you want to get electricity prices to some predetermined level of affordability that affords grandma a cosy home in retirement you have to actively suppress the market with supply. That’d be base load supply. And the base load supply guy better not also be running non base-load generation AGL-style.
    Sorry to drop a bombshell but the whole NEM debate is simply proving that electricity is a public good.

  14. Texas Jack

    Anybody actually read this?

    …modifying the National Electricity Market (NEM) as necessary to meet the needs of future diverse sources of non-dispatchable generation and flexible resources including demand side response, storage and distributed energy resource participation.

    Where’s Judith Sloan when we need her? They’re embarking on building a bigger mess.

  15. Mark A

    Texas Jack
    #3155235, posted on September 14, 2019 at 4:36 am

    Speculators speculate. Exploiters exploit

    I have absolutely no problem with this.

    What I have a problem with is that gov. gives them a leg-up, facilitates the conditions for them even.

  16. Rafe Champion

    What Mark A said, the problem is the incentives set by government regulations and the distortion of subsidies.
    The system before the NEM and RE rubbish worked fine. Anything new that came into the market had to make its way on the basis of price and quality, whatever counts as quality, I suppose reliability for power.

  17. Dust off the books from the 1990’s and see how the system worked then.
    Compare and contrast.

  18. Texas Jack

    Rafe and Mark A,

    I obviously have no problem with speculators either. I am one. That’s how I make my living, and have done for 30 years. I buy from willing sellers, and sell to willing buyers. I win my battles before I do anything.

    The problem I’m referring to is the community’s to solve. Unlike the overnight cash rate there is no RBA for the electricity grid (thought?) and therefore no upper-bound for where the NEM could theoretically take electricity given the current “energy mix” or not. The renewables folly drives the mispricing opportunities, the peakers can choose to delay peaking. As Rafe has pointed out – the base load despatchable capacity of renewables is zero, so we have this wonderful situation where it’s legal for wolves to greet lambs in the same paddock. The lambs are ushered in by the COAG energy dunces who are led around by Greens advocates and our federal Rhodes Scholar is too dumb to realise where it’s all headed.

    Why don’t we write a submission to the COAG review? Get bipartisan support for a zero-rate of taxation on any proven base-load despatchable generator profit that can be earned below an agreed emissions intensity. Let the tax incentive do the work to inflate the discounted return profile. Stand back.

    Thoughts??

  19. Linden

    Gee I knew I’d forgotten something, just could not put my finger on it! Storage of course, silly me.

  20. Rafe Champion

    Thanks Texas, what about reducing the price of RE certificates to near zero?

  21. Ben

    What about deleting the semi-scheduled generator category – provide dispatchable power or don’t connect.

  22. that can be earned below an agreed emissions intensity.

    There we go, playing their game by their rules.
    Admit emissions intensity has anything to do with the climate (give an inch) and the totalitarian environazees will take a mile and more. They’ve operated that way for a long time now.
    We never learn.

    Solution is simple, the politics of it is difficult without balls and public support.

    Get rid of all references to emissions, climate, carbon pollution etc;
    Get rid of all subsidies and targets;
    Ensure competition;
    Let all stand on market principles. Supply reliable power at prices people are willing to pay;
    Watch electricity prices fall to 15c per kWh or less.

  23. Texas Jack

    Thanks Texas, what about reducing the price of RE certificates to near zero?

    That too! Why not do both?

    The best way to beat Baa Humbug’s Environazis is tax incentive that delivers nuclear and drives renewables to zip (which is where I thought you’d join the dots).

  24. Linden

    Found this all very interesting, and I’m sure there are many out there who like myself really don’t understand what is happening with all this stuff.

  25. Tezza

    A wonderfully elegant way to distract from the fact that and reliability fallen and average price to consumers has tripled, business users have gone broke and households have slipped into energy poverty, in order to have zero effect on anybody’s climate on any time scale under any imaginable international developments.

    It’s a giant con that has produced worse ‘infant industry’ rent seeking wastage of resources than the auto industry and ‘made to measure’ protection at its worst.

  26. cohenite

    What a bunch of bullshit:

    There is a common misconception, possibly arising from these simple terms, that in energy-only markets all generators are paid the same for all the electrons they produce. That would certainly be problematic as different generators have very different strengths and weaknesses: gas, coal, hydro, wind and solar.

    Wind and solar have no relative strengths; they exist for one reason: as an addendum to the lie of alarmism.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.