Issue 33 September/October 2007
Not surprisingly, all the media attention on the Owen Report to date has been focused on its recommendation that the New South Wales Government privatise its retail and generation power assets.
But behind Professor Tony Owen's review lies an equally interesting report undertaken for him by Morgan Stanley.
The consultants have looked beyond NSW in presenting their commentary. Surveying the national electricity market as a whole, they warn federal and State governments that there is a price to be paid for ongoing uncertainty about greenhouse gas emissions management.
That price, say Morgan Stanley, will be paid by the community in terms of power bills and the reliability of the electricity supply system if there is a "freeze" in power station investment.
They point out that investors in new generation infrastructure now know that they will face carbon trading in Australia from 2010-11, but lack critical details of how it will operate in order to assess its impact on their development options.
"There is a complete lack of appetite to invest in new coal-fired power (because of) the high level of uncertainty," they say. "This risks compromising the efficiency and reliability of the national electricity market over the next 5-10 years as delayed investment decisions will take time to catch up (with demand)."
Morgan Stanley note that private investors cannot hedge against regulatory and policy risks, with delayed investment decisions being the only logical response. The consequence, they say, is that investment decisions will be delayed until developers have "sufficient headroom" -- that is, sufficiently high market prices responding to shortages of supply -- for a project to absorb carbon penalties even if they turn out to be higher than expected.
They warn that investors have long lead times for large, baseload generation investment and need to form a view of likely market wholesale prices for electricity four to seven years in the future.
"Hesitancy in investment in new power generation exists today," add Morgan Stanley. " This will become critical to outcomes in the NEM over the next three to four years, depending on overall demand growth."
The consultants argue that the level of target for greenhouse gas emissions from power stations needs to be spelled out sooner rather than later so that new generation investment can be planned. "The only effective way to resolve the risk is for the key details of the carbon trading scheme to be developed and released to the market."
Both the Federal Government and the Opposition have avoided setting out a medium-term target in the run-up to the election and both are avoiding commitment on actual levels of caps on emissions and penalties for missing targets because these are potential political dynamite in an election.
The largest sector at stake in the new carbon constrained regime both the Government and Opposition propose to introduce will be energy-intensive manufacture, which uses a third of the power produced in Australia and directly employs 1.1 million people. The high-use manufacturers face large market risk if the price of electricity in Australia reduces or eliminates their competitive advantage over rivals in the rest of the world.
Industries at risk include food processing, automotive manufacture, plastics and chemicals production, and cement, aluminium, pulp and paper manufacture.
As Tony Owen points out in his report, both the present Federal Government and a potential Rudd Government find themselves between a rock and hard place on generation investment uncertainty. The creation of a national emissions trading scheme involves complex design that, his report states, "must encompass all major emitters whilst simultaneously protecting energy-intensive export industries from competitors not subject to a carbon price regime."
Morgan Stanley say in their report to Owen that government can probably get away with delaying the announcement of the emissions trading details in to 2008 -- "or 2009 at the outside" -- because the power market will make quick assessments of investment opportunities once the information is available. But even this delay, they point out, is likely to result in the market "being less efficient than would otherwise occur."
In the absence of clarity on emissions trading -- or the emergence of a high power price that can absorb investor forecasting errors about the price of carbon -- it is likely, Morgan Stanley conclude, that investors will only build gas-fired power plant in New South Wales.
"This will keep the lights on but may not be the least-cost choice and, in the absence of effective competition from coal, may be higher (priced) than it otherwise would be."
While The Australian's Matthew Warren (26 September) believes the ALP will commit to increasing the mandatory renewable energy target (MRET) to 20 percent during the federal election, Labor environment spokesman Peter Garrett, who is taking a battering from the environmental movement and the Greens over the Tasmanian pulp mill, is remaining coy on what the party plans for renewable energy if it is elected.
Garrett is prepared to say only that the target will be "significant" -- by which he presumably means "substantial."
Meanwhile the Howard Government's new clean energy target, which aims to increase renewable power supply to 15 percent of consumption by 2020, is causing grumbles among the gas industry. The gas suppliers stand to gain in the national electricity market, from the introduction of emissions trading, but cannot achieve the emissions level of 200 kg/MWh that has been announced for the CET.
The existing MRET requires retailers to buy 9,500 GWh of new renewable power -- in addition to the 16,000 GWh produced by hydro-electric generators -- by 2010 and to hold to this level until 2020. Under CET, the mandatory target will be set at 30,000 GWh by 2020, chewing substantially in to the market share gas generators would hope to capture under emissions trading.
The Australian Petroleum Production & Exploration Association complains that a pre-occupation with renewable energy distracts from "practical action" now and pointedly refers to the Queensland Government's requirement for 13 percent of the State's electricity consumption to come from gas.
Why do most State governments persist in hanging on to segments of the electricity supply business more than a decade after the initial push for power privatisation? The Productivity Commission review of the financial performance of government trading enterprises across the country reveals the answer: in the two years surveyed -- 2004-05 and 2005-06 -- the power GTEs contributed $2.5 billion in dividends to the State and Territory governments. The contribution jumped $214 million in 2005-06 over the previous year. The sums for the two years include $180 million paid by Snowy Hydro to its three government owners -- Victoria, NSW and the Commonwealth.
A coalition of Australian businesses styling itself the Australian Business & Climate Group -- made up of BP, Rio Tinto, Westpac Bank, insurer Swiss Re, Santos, Anglo Coal and consultants Deloitte -- has shone a light on the perils of red tape for companies attempting to new power technologies in to commercial operation.
The ABCG, which wants a low-emission technology strategy to be introduced to complement emissions trading, says that uncertainty over regulations is hindering long-term investment in "next generation" assets.
The group says some low-emission technologies rely on specific geological resources and follow an exploration process as complex and expensive as other mineral resource exploration.
"Locating large amounts of high quality, secure and low-cost hot dry rocks, for example," says the group, "is as complex and expensive as exploring and defining any ore body. The costs can only be recovered when titles can be granted and the project's carbon value can be determined."
As a result, argues the ABCG, considerable first-mover risks exist for investments made before regulation is determined. Technologies such as carbon capture and storage, it adds, require new and complex regulatory frameworks. The group warns that such regulatory issues compound the already high costs of the demonstration and deployment of break-through technology. "Such uncertainty is a significant barrier for first-of-a-kind plant as it is virtually impossible to recover the costs from the market."
It would be easy to portray a boom in Australian petroleum exploration at present -- after all there was a 128 percent increase in expenditure on the offshore search in 2006-07 compared with the previous financial year, and onshore exploration outlays were up by 35 percent. In all $1.43 billion was spent.
However, reality is to be found in the physical search details -- offshore drilling rose 41 percent and onshore drilling just 7.4 percent. The reason the money figures look so much more impressive is that there has been a "dramatic" (to quote the industry lobby group) rise in exploration costs. The actual amount of exploration, of course, is the more telling set of numbers, not the dollars spent.
Meanwhile analysts EnergyQuest report that petroleum production in Australia jumped 10 percent in 2006-07, reaching the equivalent of 472 million barrels of oil equivalent. Gas production rose 8.9 percent and oil production 16.6 percent.
In its latest report on oil prices, the Federal Government's commodities agency ABARE forecasts that oil prices will remain high in the rest of 2007 and in 2008. It estimates that the international oil price will average $US67 a barrel for 2007 and to sustain this level next year. In the first half of 2007 averaged just over 85 million barrels a day and ABARE predicts that 2008 demand will exceed 88 million barrels a day.
The New Zealand Government's decision to require 90 percent of the country's power to come from renewable energy by 2025 does not fuss the electricity generators, so long as they can be allowed to access hydro systems.
In reactions to the announcement, both private and government-owned businesses have pointed out that they expect New Zealand to need 10,000 MW of capacity by 2025 -- compared with 7,500 MW today, of which 65 percent (4,800 MW) is hydro. However, they add, the largest existing coal-fired station will have reached the end of its life by then and this will leave just 1,400 MW of coal and gas burning plant to contribute to supply.
They also point out that wind farms, totalling just 200 MW at present, will not be taken beyond 2,000 MW because of the problems intermittency causes for the high voltage transmission system.
That leaves a large gap -- which the industry argues is not going to be filled by non-hydro renewable sources over the next 18 years.
Meanwhile the latest calculation of likely capital outlays on renewable energy worldwide -- undertaken by Ernst & Young -- sees it reaching $US750 billion annually within 10 years. It reached $US100 billion in 2006. The consultants point out that they predicted in 1997 that renewables growth would reach $US70 billion a year by 2006 and this figure was considered "ambitious" by other analysts.
A United Nations review has also claimed that low-emission electricity capacity investment could reach $US148 billion annually by 2030.
The Energy Networks Association says investment in augmenting Australian electricity networks and gas pipeline systems now stands at $5 billion a year.
ENA chief executive Andrew Blyth says Australian cities are rapidly reaching the design constraints of energy networks built in earlier decades. "This is not to say that reliability will fail or falter," he adds, "but it does require a recognition that a large set of assets that support strong economic growth are at the end of their lives." He puts the capital requirements for the network system at $40 billion.
Whoever wins the federal election -- which at the time of writing is being mooted by my contacts for 17 November -- the ground will shift in the next three years for the domestic energy industry.
Both major parties are now committed to not only introducing emissions trading but also to substantial increases in the mandatory targets for renewable energy (and low-emission energy in the case of the Coalition, but realistically this means renewables until carbon capture and storage technology becomes commercially viable).
Should the Coalition be re-elected -- and the prospects of this happening are not at such long odds as the public polls and the majority of the media suggest -- there will be a struggle between it and the States over renewable energy targets. It is highly unlikely that Victoria, NSW, South Australia and Western Australia will want to allow their schemes to be subsumed in to the clean energy target recently announced by John Howard and Malcolm Turnbull.
Also, if the Coalition retains office -- which would require it to hold its Tasmanian seats, add to its seats in WA and reduce the losses in NSW and Queensland currently anticipated on the basis of the polls -- there will be conflict over moves to permit more uranium mining, opening the door to miners in South Africa and elsewhere to gain market share in the predicted nuclear boom of the next decade.
Both the Coalition and the ALP will be on the receiving end of the gas industry's unhappiness if their renewables targets undermine the much-anticipated dash for gas in generation between now and 2020. The gas industry has waited a long time for its moment in the sun with respect to power generation and anticipates building its share of the electricity market from a lowly eight percent today to almost a quarter by 2030.
Once the election is out of the way, the NSW Government can be expected to finally make some decisions about the power industry -- both with respect to the next tranche of generation and how far it is willing to go in privatising its corporations. The retail arms of the three network businesses are widely considered a racing certainty to be sold, but whether the Iemma Government has the intestinal fortitude to stare down the unions and sell off some or all of its generation capacity is problematical to say the least.
Getting State governments to give up their regulatory price caps on retail electricity will also be important to suppliers over the next three years -- and the networks sector will be looking to the regulators to approve capital spending on "poles and wires" for the five years from 2009 running to tens of billions of dollars (and adding to the upward cost pressures on electricity that will flow from carbon measures).
Somewhere in the next 12-18 months the federal and State governments will also be asked to come to a final landing on the proposed national planner for high voltage network systems as a result of the recent ERIG report.
There is also the question of what to do with Snowy Hydro, still owned by three governments after the botched privatisation attempt in the past year. The issue is not going to go away and, should NSW sell its other generation interests, it will hardly be able to justify retaining a hold on the Snowy
In addition, of course, there is a mountain of work still to be completed through the Ministerial Council on Energy in terms of ongoing reform of the national electricity market, a process running substantially behind schedule and needing continuing Federal Government pressure to ensure full delivery.
Next year will also see the federal Energy Efficiency Opportunities program -- launched this year and which requires detailed reporting and commitments to future action by Australia's 250 largest energy users, who account for 40 percent of consumption -- start having a real impact. Regardless of who wins the election, energy efficiency -- especially in the business sector, which accounts for 72 per cent of Australian power demand -- can be expected to be higher on the agenda of carbon constraint policies.
The cumulative effect of greenhouse gas abatement policies on expansion of existing energy-intensive manufacturing operations and on new investment in this sector is one of the big unknowns of the next decade. If "unintended consequences" see some existing plants shut down and new developments fail to occur, there will need to be a significant rethinking of Australian power demand out to 2030 -- and this is a sector that today accounts for a third of all electricity consumption -- with implications for supplier revenue too.
Back in the 1990s, when I was managing director of the Electricity Supply Association, a position I held from 1991 to 2003, I discombobulated an industry audience in responding to a question about when I thought the electricity reform process would be completed. "Never" was my answer and events over the past decade have validated what was an unpopular perspective on the day. There certainly isn't much doubt today that the change process will roll on in to the next decade.
9 October 2007
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