20
Jul
2016

From reliable and cheap to patchy and expensive: South Australia’s energy policy

by Tony Wood


Published by the Australian Financial ReviewWednesday 20 July

High and rising electricity prices and a growing risk of supply disruptions have hit South Australia hard. Politicians, industry and renewable energy advocates are all rushing to lay blame. And South Australia’s woes today may affect other states tomorrow.

So what happened, who is at fault and what should be done?

The electricity system that comprises the eastern states, the ACT and South Australia is known as the national electricity market (NEM). The state systems generate power to varying degrees, while interstate transmission lines allow excess power in one state to be exported to its neighbours. A wholesale market was introduced in 1998 to set wholesale prices for electricity and provide price signals for supply to respond to demand.

This system has delivered power reliably, at generally low and stable wholesale prices. It was based on large, centralised generators with mostly predictable and stable output, and competitive bidding by these generators to sell their power on a daily basis. In addition, rising consumption was a feature of the NEM for most of the 2000s.

But over the five years to 2015, consumption across the national electricity market fell consistently. It did so for several reasons, including high network prices and exchange rates that suppressed manufacturing output. At the same time, the Commonwealth’s legislated Renewable Energy Target (RET) forced into the market an increasing quantity of distributed, intermittent supply from renewables.

The market worked as it was designed to, and produced low wholesale prices. But that put so much financial pressure on traditional coal and gas power generators that some plants were either mothballed or permanently closed. For a time, low wholesale prices largely offset the additional cost of renewable energy and continuing oversupply ensured reliability.

All may not be well

It was an unsustainable situation. During 2015, electricity consumption stopped falling and showed signs of slow recovery. Highly favourable subsidies and ideal local conditions led South Australia to secure high levels of wind and solar power under the RET. The share of fossil-fuelled generation fell, as did the availability of these plants that also maintained the technical stability of the electricity grid. To ensure reliability, the state grew increasingly dependent on its transmission interconnection with Victoria. Last summer, the Australian Energy Market Operator raised concerns that all may not be well.

Since early 2015, wholesale prices have risen steadily across the NEM in response to demand. The forward price in South Australia reached levels twice that of other states, alarming large commercial customers in that state. Then cold weather, some plant outages and the closure of others led to high prices.

Gas generators that run purely to meet peak demand would normally set the price and they did. But there were fewer of them due to closures and gas prices had risen dramatically to match the price set by gas exports from Queensland. Prices briefly doubled in most states and more than trebled in South Australia. The NEM was not designed for these changes.

Blaming the perceived failure of the wholesale market, inadequate transmission planning or the intermittent nature of wind and solar is unhelpful. There has been a systemic failure to understand and address the consequences of poorly considered policy. The absence of a credible, long-term climate change policy to ensure effective and efficient investment has not helped. Nor has a dysfunctional COAG Energy Council (CEC), the national body of federal, state and territory energy ministers.

Timely move

State and territory politicians are demanding answers and the Australian Energy Market Commission has announced a review of the security of the system. On Monday Josh Frydenberg was given ministerial responsibility for climate change as well as energy, a timely move that aligns with recognition by the CEC of the critical relationship between policy in these two areas.

Action is overdue. Minister Frydenberg should lead the CEC to act with clear responsibilities, a firm timetable and a required outcome.

The 2017 review of climate change policy should begin immediately, with a priority to strengthen and evolve the existing Safeguard Mechanism so that it becomes an effective market mechanism for reducing emissions and driving new investment. The NEM should be reviewed, considering alternative or additional mechanisms that may be needed to avoid future threats to reliability and/or prices.

Other countries, including Britain and Germany, are also struggling to transform their energy systems. They provide no easy answers for our uniquely Australian system. The one good thing that could come from the South Australian mess is a genuine and comprehensive commitment to producing reliable, affordable and low-emissions energy that will serve Australians for years to come