Two-speed market

Timely is the word for the newest energy report, published today – the Australian Energy Market Commission’s annual review of the state of retail competition across the east coast.

And AEMC chairman John Pierce sums up the market problem in one more (hybrid) word: two-speed.

“We are seeing a two-speed market,” he says. “While competition is driving innovation and new choices for consumers in the retail market, these benefits are under threat by a wholesale market with rising costs. It’s critical that future policy on emissions reduction facilitates commercial investment in generation in the right place at the right time and supports a liquid forward contracts market so retailers can effectively manage their risk and keep prices as low as possible for consumers.”

The review finds that, while NEM retail competition is stronger and delivering benefits for consumers, higher wholesale costs are driving up retail prices. “This,” says Pierce, “is putting these benefits at risk.”

Rising wholesale energy market costs are being driven by a range of factors, the report comments, including the increasing costs of hedging contracts.

“Fewer generators can provide hedging contracts due to the lack of an emissions reduction policy that is properly integrated with the energy market, while generator retirements are reducing the supply of contracts. This, along with higher gas prices, is increasing the costs of doing business for electricity retailers, especially smaller retailers with innovative offerings. The risk of these electricity retailers leaving the market is growing.”

I don’t think anyone can accuse me of being naïve about our politics – I can point to a 40-year career of close working contact with politicians, federal and State – but, the situation being as the AEMC describes it, I find it amazing that our leaders, Malcolm Turnbull and Bill Shorten, can talk this week about getting together to discuss four-year terms for federal MPs while continuing to play wedge politics with something that literally affects the lives (and livelihoods) of every Australian.

A “summit” meeting of the leaders to resolve a mess that has been a decade in the making at the hands of both sides is beyond their wit and wisdom – is that what we are to take from the current situation?

Political writers of all stripes are telling us that the state of energy prices is now so troublesome for the community that the future of the current Coalition government may hang on it at the next poll.

The reason why is clearly set out in the AEMC report: “There is currently increasing upward pressure on retail energy prices. This is largely driven by factors outside the retail energy sector.

“In recent years, retail pricing outcomes have become increasingly dependent on outcomes in the wholesale energy market. The AEMC’s price trends reports show that nationally for electricity, the wholesale component’s share of residential prices increased from an estimated 19.6 per cent in 2014-15 to an estimated 28.6 per cent in 2016-17.

“The increases in electricity wholesale costs have been due to a combination of (a) generator retirement, combined with increases in gas prices and (b) the distortionary impact of having an emissions reduction policy mechanism not properly integrated with energy policy, in the form of the large scale renewable energy target.”

The reports adds this: “Since the announcement of the retirement of Hazelwood there have been large increases in forward contract prices for electricity across the NEM. This has been due to the expectation that electricity supplied by Hazelwood is replaced by more expensive black coal and mid-merit gas generation in New South Wales and Queensland. The cost of gas-fired power generation has recently been affected by higher gas prices and concerns about the availability of future gas supply.”

And, critically, this: “The RET has resulted in an increasing penetration of renewable energy generation in the wholesale market. Due to (its design), the new generators do not have the same incentives to enter into firm capacity hedge contracts as a means for financing their investment. They can instead finance investment through the separate source of revenue derived from generating certificates.

“The result is that the new generation adds to the physical capacity in the system, but, due to the design of the RET scheme, results in no corresponding increase in the supply of firm capacity hedge contracts.

“Further, the new generation incentivized by the RET contributes to the retirement of the older generation plants that were supplying the firm-capacity hedge contracts.

“Consequently, the supply of firm capacity contracts is diminished, increasing the cost of contracts, which affects retail competition.”

One of the tedious memes of past years in this debate was “death spiral,” applied to networks and fortunately now kicked in to the sidelines, but it is clear from what the AEMC is saying that the market is caught in a “pain spiral” that can’t be quickly or easily resolved but must be fixed in the interests of householders, small businesses and all forms of trade-exposed industrial activity.

The commission tells the body politic: “Any emission reduction policy that is introduced must consider the enduring effects it may have on the energy market. In particular, how it affects not only the level of investment in physical capacity, but also how that investment in generation is financed.

“Emission reduction policy mechanisms that incentivise investment in electricity generation capacity without incentivising the ongoing supply of hedge contracts risk adversely distorting wholesale and retail market outcomes. They will inadvertently lessen the emerging competition from innovative new retail energy businesses and place upward pressure on consumer prices.

“Conversely, where an emissions reduction policy is effectively integrated and aligned with the design of the NEM, it is likely to lead to a higher degree of investment certainty in the energy market and more availability of contracts. This will reduce pressure on the wholesale electricity market and result in lower retail prices for consumers.”

The report also contains this warning for those who may be taken in by the ululating from green boosters on the cure-all offered by lots more renewable power: “In the short term, the entry of low-marginal cost renewable generators incentivized by the RET can lead to a decrease in the wholesale electricity price. However, this decrease is only likely to be transitory. Lower spot prices can lead to, and have led to, the exit of thermal generators that cannot fully recover their generation costs with low wholesale prices. Once this occurs, wholesale spot prices will increase again.”

These aspects of a 339-page report encapsulate the major challenge for the Coalition and Labor at a national level – there is another, and it is highly important, resolution of our domestic gas imbroglio, but achieving this (which is unlikely in the short term) will not deliver pain relief without the issue the AEMC has set out so clearly being properly addressed.

Is pursuing the national interest as soon as possible by fixing the “two-speed” NEM really beyond our political leaders? And, to be clear, “asap” here means “now” — not by setting up more task forces and inquiries.

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