The Grattan energy team is back with a new podcast on our latest report, Out of gas: Managing the decline of gas in Australia. In this episode, our energy experts dig into the detail of their longest report yet.
Joining the conversation are report authors Alison Reeve, Program Director; Hamish McKenzie, Deputy Program Director; and Associate Ben Jefferson.
Transcript
Hamish: On thethe 31st of May, Grattan published the Energy and Climate team’s longest report ever, “Out of Gas: Managing the Decline of Gas in Australia.” This report was ambitious in its scope and its recommendations. In it, we argue that gas is in structural decline and that governments must accelerate and better manage that decline to largely phase out gas in Australia and to do it safely.
Gas is going through a transition from a ubiquitous fuel used by millions of households and businesses every day to a rare one used perhaps by a few hundred industrial facilities, and much of that using renewable gas. And we didn’t shy away from the thorny issues, what to do about our LNG exports, how to deal with expensive gas pipelines that we won’t need, and how to manage gas in the power sector. Last week, we released the first of two episodes of the Grattan Podcast on this report, and today we release part two, where we’re going to dive deeper into some of the more complex parts of the report. If you haven’t listened to part one, we recommend doing that first. These are contested topics and not everyone agreed with where we landed.
If gas is to go through this transition to a much smaller role in a mostly electric economy, there will of course be winners and losers. So we wanted to come back and speak to some of the issues in more depth. Grattan is all about encouraging public debate, and the public has really engaged on this one. So we’ve brought together Alison Reeve, our program director and lead author, Ben Jefferson, our program associate, and me, Hamish McKenzie, the deputy director of the program.
And today we’re going to dive into three of the biggest topics we explored in our report: phasing out gas distribution networks, building up a renewable gas industry, and managing the critical but small role of gas in backing up the power system. Alison and Ben, good to have you.
Alison: Hey Hamish.
Ben: Good to be here, Hamish
Hamish: Before we dive into the real content, let’s just start with a bit of a temperature check.
Ben, this was your second report at Grattan. Our chapter on LNG was one of the main topics that you focused on in this report, and that turned out to be pretty challenging, in part because the Iran war happened while we were writing the report. What was your experience of trying to understand the picture for Australian LNG exports in the context of such a dynamic situation with a major war and an LNG crisis?
Ben: Yeah, it’s really interesting and LNG and gas exports in general for me was one of the most interesting topics we covered in the report. There’s a temptation to think of the export sector for gas , as completely separate from domestic gas use. But when you get deeper into it, you realize there’s actually lots of interdependencies and linkages.
The exporters buy and sell gas from the domestic market. That means that prices get linked. And there’s also a big emissions component to it. Even though we don’t burn the gas we export in Australia, about 40% of our gas-related emissions come from the export sector just from producing and digging up the gas.
So when we started the report, we had a pretty strong hypothesis that Australian LNG was about to go into a downturn. The situation from demand is really uncertain over the next 25 years. There’s lots of puts and takes on whether or not there’ll be more or less demand. But what we do know is that there will be a lot more supply coming online over the next five to 10 years.
There’s meant to be a 50% growth in the capacity to send LNG overseas. And so because Australia is a relatively high-cost LNG producer, we thought it was pretty reasonable that LNG would follow the government’s forecasts and decline. What then happened during the course of the report was the war in Iran.
You saw restrictions on exports, you saw a destruction of significant capacity to produce LNG in Qatar, and that obviously puts a big dent in the forecast supply. So at times we were updating the report literally by the week just to try and figure out what we thought the medium-term narrative was.
Where we eventually landed though, was that the longer-term narrative ended up remaining broadly consistent. Demand remains really uncertain and what people are going to do in response to this crisis remains uncertain. There’s some security premium on Australian LNG in the short term, but in the long run there will continue to be a lot more supply coming online.
A lot of that supply will come from the US and will still reach markets. And while there was this kind of strategic consideration around whether or not it’s important to have more gas in Australia for strategic considerations with the oil crisis, a lot of the gas we sell overseas doesn’t actually go to countries we buy oil from.
So it’s probably not as strategically important as some people thought.
Hamish: I think even today there was news of fresh strikes in Iran, and pretty much every week we went from there’s a peace deal to now we’re back at war. And it just speaks to why we tried to take that really long-term picture because yes, there’s these short-term dynamics that might affect the market this year or next year, but actually long term, we think that the picture looks like there’s pretty strong headwinds for Australian LNG.
Alison, this is your 11th report by my count at Grattan.
Alison: Can’t believe I’ve done 11 reports
Hamish: 11 reports. And counting. What was your experience of putting this report out as opposed to previous reports?
Alison: I have to say, having a war in the middle of the report that completely changes the operating environment, that was definitely a first.
But the policy environment doesn’t wait for Grattan to put its report out. It changes and you have to move and adapt to that. But I think this one just did have that extra degree of difficulty because of the international situation. The other thing though about this one, like every time we do a report, we often get surprised about what catches the public imagination once the report’s out.
And with this one, I think the thing that really got picked up when we first published the report was this idea that gas is actually in decline and has been in decline for a long time. And that’s so counter to the narrative that’s actually been playing out whether that’s around things like the gas tax whether that’s around things like exports, fuel security, everything else.
And I think it really shows why it was important to write this report because there is that gap between the public perception and the political perception of gas and what the reality actually is. And that was why in putting the report together, we had this sort of note running through it of this decline is going on, you have to wake up to it and deal with it because otherwise it’s going to be very costly and very disruptive.
The other sort of thing I felt with this report too was, like you said, this is the longest report we’ve ever written. I knew the gas system was big and important but once we got into the report, there was just so much complexity and so many linkages between all the different parts, and it really showed that the whole system rose together and the whole system’s going to decline together.
You can’t really chop off a separate part and say, “Let’s deal with that.” You do have to think about all of those consequences that go all the way across.
Hamish: Just on that point about the fact that, gas is declining and it is gonna be unmanaged, it’s gonna be costly and disruptive. I think for me, the biggest place that comes out is really through the distribution gas network, the system of pipelines that delivers gas to people.
I think that’s where the rubber hits the road most clearly. So let’s turn to that. We argued that we actually need a complete shakeup in the regulatory model for the gas distribution pipelines, and that because demand is declining on these pipelines, we largely should phase these out over the next 20 to 25 years.
Before we get into the details of our proposal to do that, Ben, could you just set the argument out for us? We make the case that these networks are on a pathway to an expensive and disruptive collapse. Why?
Ben: The first thing, Hamish, is that when you pay your gas bill, you’re not just paying for the gas itself, you’re actually paying for all of the supply infrastructure that sits behind that. So all of the pipes in the ground and the related infrastructure and the services that actually get the gas to your house, that actually makes up about 40% of your gas bill. And so we know now there are actually lots of households starting to leave the gas network, and in the last five years or so, household use across Australia has declined by 16%. In the last year, we’ve seen more people leaving the gas network than connecting for the first time.
But the pipes are mostly staying put, so that means that the network cost, the amount that you need to pay to keep all of those pipes going and to build them, that 40% is going to go up because the number of people who are paying to cover it is going down, but the costs are remaining more or less the same.
And the energy regulator is forecasting that this demand decline is going to continue. In fact, it’s going to accelerate. There’s going to be an 80% household demand decline by 2045 on the East Coast. And they’re saying that could put your household bills for gas up by 100% by 2035 and 600% by 2050.
For one of the gas networks we looked at, so the people who are actually providing the pipes and infrastructure, 80% customer demand decline means they would lose 70% of their revenue. This is a really big deal. To get ahead of these problems, to reduce the costs that people are actually paying, the gas networks are going to try and decommission these gas networks, but that’s really expensive and there’s currently no plan for how that’s going to happen, who’s going to pay for it and when it’s going to take place by.
So the risk is that the people who are left paying the bill for all of those things are going to be renters, people in apartments, and people who just can’t afford to electrify, the last people left on the gas network.
Hamish: So I think this is a really important point to just sit with for a second. Those forecasts from the Australian Energy Regulator that if demand declines in the way that it is forecast to, and if we don’t update the regulatory model, gas bills could double by 2035 and go up 600% by 2050. What that functionally means is that the gas network will collapse.
People won’t sustain paying gas bills double what they are today, let alone many more times than that. That’s not an outcome that anyone can really countenance. So what that is telling us is that this regulatory model is not sustainable, and as soon as in a decade, we’re gonna run into a situation where people simply can’t pay these bills.
The networks don’t have a viable commercial model, so we don’t actually have a huge amount of time to fix this problem. So let’s turn to what our solution is. We’re certainly not the first people to point out that there’s a regulatory problem in the way that we do gas distribution regulation in this country.
But we did lay out a new solution. We’re calling it a grand bargain to share the costs of shutting down the networks over the next few decades. There’s a few different buckets of remaining costs, and government could choose to allocate those costs between, consumers, between gas networks or governments themselves, really in any way they like.
We’ve put out a particular proposal for how to allocate those costs between those groups. Alison, do you wanna lay out the core components of what our grand bargain is?
Alison: I think the first thing to say is we thought it was the fairest solution was to share the cost between the people who own and run the networks, and also actually other businesses in the energy sector that have benefited from the use of gas in the past, and also the businesses that in the future are gonna benefit from electrification.
We also thought some of this should go onto consumers because having a well-functioning running network is something that ultimately benefits all of you, even if you yourself are not using it. And some of the responsibility rests with government because it is government that has signed up for emissions targets. And that’s what’s created the consequence of those, is that this network is gonna decline. So you’ve got three types of costs. There’s the cost of taking individual gas connections, say the connection to your house. You’ve got the cost of keeping the network going ’cause it has to stay safe and reliable right until the very last user leaves the network.
And then you’ve got decommissioning costs because you can’t just leave the pipes in the ground. You’re risking things like those pipes collapse and you get subsidence and that sort of thing.
Now, what we proposed for the sharing is that at the moment, consumers are already paying part of that cost because there is this thing called accelerated depreciation, where the gas companies have been allowed to bring forward revenue that they would’ve recouped from the future, from future consumers and recoup it now.
We’ve said that should be allowed up to a point but beyond that point, we need to start talking about decommissioning rather than keeping the whole network there. And that cost needs to be partly paid for through government and partly paid for by the networks, and they should not be able to pass that cost back to consumers, which is what they can do at the moment.
Hamish: Just on accelerated depreciation, the reason we think it should be limited is because if you allow unlimited accelerated depreciation, it risks putting up gas bills too high. Maybe just speak to that point.
Alison: One of the problems with accelerated depreciation is that because you’re taking things that would’ve been paid for in the future and you’re paying for them now, you push gas bills up now. And to the extent that anybody is price sensitive and wants to leave the network because their costs are too high, they will leave earlier than they otherwise would, which means you’ve then got fewer people to pay for the network.
You’re in that same spiral which is just bringing forward the date at which the network is not viable anymore.
The other thing that needs to sit alongside all of this is changes to regulation, ’cause at the moment, the national gas law doesn’t actually allow for decommissioning. When they wrote that set of laws, they were written for a network that was going to keep growing forever, and we’ve now got a network that’s shrinking.
And so we actually need to change things in the national gas law to account for the fact that we are going to have a network that is getting smaller and smaller, and that we do need to do decommissioning. And as part of that actually we think networks should have the right, with an adequate notice period, to cut people off from the network.
At the moment, they’re not allowed to do that unless someone has persistently not paid their bill. But unless you give them the right to actually manage their network in a way that’s efficient, we’re gonna end up with higher bills for everybody.
Hamish: There’s also a piece here about making sure that networks themselves actually end up paying some of these costs. The way the regulation works at the moment is that almost any expenditure that the networks make can be passed back to consumers because they have a regulated right to recoup those investments.
And so we were quite clear that if government wants consumers to pay the entire cost of winding down the gas networks that’s a choice that they could make. We don’t think that’s the right one. We think networks should pay a part of the cost. If you want that to happen, you need to reform the gas law to excise certain kinds of expenditure from their regulated base, meaning they can’t pass those costs back onto customers.
So I think that’s a really important part of the way that we’ve conceptualized this grand bargain. If you don’t have that reform, then customers will just end up paying for everything.
Alison: Yeah, that’s right. Ultimately what we’re saying is that the shareholders of those gas network companies should be taking basically a lower return on their investment as part of sharing of that cost
Hamish: So one argument that people sometimes make, and they certainly made it in response to our report, is that we may not need to decommission the gas distribution pipelines because we might just end up with a whole bunch of renewable gases to replace the fossil methane that goes through the pipelines. Now, theoretically, if we did have, infinite quantities of low-cost renewable gas, we could theoretically just pump that through the pipelines, and we could keep using gas in much the same way as we do today. We wouldn’t need to have this expensive decommissioning project. That’s not what we concluded in the report.
Ben, you led a lot of the analysis on renewable gases. Can you explain why we concluded that we can’t just rely on renewable gases to replace fossil methane in the pipelines?
Ben: Yeah, absolutely, Hamish. I think as you alluded to, one of the main things is just the sheer cost and availability. From where we’re standing now, it doesn’t look like we will be able to make enough renewable gases at reasonable costs to be able to replace the role that fossil methane plays in pipelines.
And so we just simply won’t be able to sub it one for one. The government has set out some ambitious targets and implicit targets for how much of these renewable gases, which are hydrogen and biomethane, that it wants to make by 2030 and by 2050. And we think that it will be really hard for them to meet those targets as is.
We’re not on track to do it. We’re probably not providing the right supports at the moment, as our report comments on. And so we think that aiming even higher and saying we’re just going to substitute one for one and have 1,000, 1,500 petajoules of renewable gases is unrealistic. Then there’s also some specific challenges just associated with the logistics of getting gas into pipelines.
So to start with, hydrogen, you can’t just replace in pipelines with fossil methane. It’s a different chemical. It has different properties. It’s a lot more volatile. So once you get past a certain amount of hydrogen in the gas mix, you actually n-need to start retrofitting and replacing those gas distribution networks.
You then come across a whole new set of costs. So with hydrogen it will be really difficult to just drop in plus the fact that it’s hard to make. And then on biomethane, you don’t have that same problem. You can just sub that in because it’s chemically the same thing. But you have a different logistical problem.
So a big gas mine aggregates lots of fossil methane, puts it into a pipeline and sends it off. But the way biomethane will be made is probably from lots of different small places, so lots of different farms and waste sources. And so only small amounts will be made, and you then need to find some way of aggregating them all together to put them into pipelines. That presents its own logistical difficulties and costs.
So considering both just the actual production constraints, the costs of producing it, as well as these logistical difficulties, we think it looks really unlikely that it’s going to be a one-for-one substitute for the role of fossil methane now, and we think it’s much more likely these renewable gases will be a critical, important supply that will generally be produced close to where they’re actually used and largely in industrial uses.
Hamish: Can you put some numbers on this for us? Biomethane, we said the most that you could realistically expect or plan for in 2050 is about 90 petajoules.
Ben: Yeah, that’s right
Hamish: Why not more? And how much would it cost to get that biomethane compared to fossil methane?
Ben: So the reason we said 90 petajoules is we basically drew a line around how much we would be willing to pay for a fossil gas equivalent. Some estimates have said that there could be up to 300, 400 petajoules of biomethane availability in Australia
Hamish: Which would be about domestic gas demand on the East Coast?
Ben: On the East Coast, yeah, about half of overall domestic gas demand if we were stretching it and if demand did decline across the board. The difficulty is that the cost of producing that biomethane is likely to be a lot higher than currently producing fossil methane. So you can produce a small amount, about 10 to 20 petajoules of biomethane at a cost that’s comparable.
When you get above that, it starts being about 100% more expensive, so double the price. The remaining 100, 200 petajoules is three times as expensive or more than biomethane. That’s the best guesses that we’ve got in terms of cost. So the 90 petajoules assumes you’re willing to pay about double the fossil methane cost to get that amount of gas, and we think that going above that’s probably unrealistic.
Hamish: So we certainly heard critiques that some people thought that we underestimated the amount of renewable gas that we could potentially get in Australia. But we also heard the opposite critique that some people think we overestimated the role that renewable gases will play in decarbonizing the Australian economy.
Electrification is obviously the main alternative to renewable gases, and there’ll be some applications of gas where it’s really hard to electrify, but many current gas users will find electrification to be the cheapest and easiest way to reduce emissions. Alison what do you think is missing from the argument that we don’t actually need renewable gases and that our report overstates the importance of these as decarbonization solutions?
Alison: There are some consumers of gas who are not interested in the energy content, they’re interested in the chemical content, and you can’t substitute an electron for a molecule in that context. So if you’re, for example, a plastics maker, a chemicals factory, an explosive maker, you’re consuming gas at the moment because you want the chemicals that are in it, not for the energy content.
So for those people, there is a need for an alternative to fossil fuel-based gas which might be biomethane or might be hydrogen or might be both. There are also some large industrial players where you need very high temperature heat, for example, if you’re melting iron ore to make iron. Now there are ways that people are experimenting with doing that through electricity.
But at the moment, the pathway that a lot of the companies see there is that they want something that is burnable. So that will mean something that is like biomethane or like hydrogen.
So those are the two groups where electrification in one case is not the right pathway, and the other one is where it’s quite ambiguous at the moment.
I think the thing to emphasize here is that even though the role of renewable gas is small, the amount of renewable gas is orders of magnitude larger than what we produce now. And that is why we actually need to put the effort into building that industry up.
We are not talking about building it up to the level where it replaces all gas use in the economy, but we are talking about it having to go through, a growth that is 10 or 100 times what it can do now just to fill that small niche that’s left.
If we don’t do that, where we end up with is we just lose whole industries.
So if Australia doesn’t have an explosives industry anymore, that makes it a lot harder to have a mining industry. If we don’t have our own fertilizer production anymore, that leaves our whole agriculture sector much more vulnerable to international shipping disruptions, for example.
We’ve got really patchy policy in this area at the moment. Governments have put a lot of money into hydrogen, possibly more money than that sector was actually able to absorb. And a lot of projects there haven’t gotten off the ground. There has been nothing like that level of support that has gone into the other forms of renewable gases like biomethane.
So what we’ve argued for in the report is not necessarily more money, but better targeting and more structured policy that takes both of those sources of renewable gases through a structured growth arc to make them into a mature and sophisticated industry that’s capable of supplying that last niche, and the rest of it is there for electrification.
I think the other thing to emphasize too is that this is not a zero-sum game. More policy support for renewable gases does not have to mean less support for electrification. One of the things that we said in the report is that there has been this policy gap around industrial electrification for a really long time, and that governments need to start filling that gap.
Hamish: I think this is one of the striking things that I learned through this report, just identifying the existing facilities that use hydrogen in Australia today. There’s 10 of them. Eight of those 10 use hydrogen for producing, ammonia, explosives, those things that we’ll need more of in a net zero economy.
And so even if you throw away all of the new potential applications of green hydrogen, and granted, a lot of those, were always probably fanciful, you still need to think, how are we gonna decarbonize these eight factories that are, currently producing good stuff that we need more of given they are all consuming hydrogen made from fossil fuels, which is high emissions.
Even if you just focused on those that’s 53 petajoules of gray hydrogen, of fossil hydrogen that’s being consumed today that we’ll need to replace. And given the existing green hydrogen industry in Australia is about zero petajoules, if you round down we’ve got a long way to go and not a long time to go there.
Alison: That’s right. And I think this is my response to the argument that, oh, we could do 400 petajoules of biomethane. We need to walk before we can run. Let’s talk about how we get to one petajoule and see how we go, because even that is a huge task.
Hamish: So one of the big policy measures that we suggested to accelerate growth in the renewable gas sectors is a demand side obligation. We know that there’s been a bit of support on the production side for hydrogen. We’re arguing for a bit more support on the production side for biomethane. But we know from the renewable energy industry and other industry policy experiences that if you really want to grow a new industry, you need to move the supply side and the demand side in lockstep.
And what we haven’t seen in hydrogen in particular, is any large players who are willing to sign an offtake agreement with a green hydrogen producer to buy their product, and we think that’s a missing piece of the picture. We suggested that the way to get around that is to place an obligation of some kind on the largest industrial gas users in Australia to purchase a quantity of renewable gases.
You could taper that up over time, and even if you started with pretty small volumes, given the fact that these industries are so small at the moment, a small amount of gas in a demand obligation would actually be pretty transformative.
Alison, you’ve got a lot of experience in renewable energy targets and these kinds of schemes. Can you give us a sense of how this demand side obligation could work in practice?
Alison: Like you said, what you’re doing is you’re finding a group of people and asking them or requiring them to buy a very small amount of the renewable gas every year. And if you’ve got enough of those people, what you can do is not put too much of a cost impost on them, but you do something that is quite transformative for the renewable gas industry, because all of a sudden it has at least some level of guaranteed market because it knows that it can find a buyer.
And if you start to build that obligation up over time, and at the same time the cost of production is falling, you keep the cost of the overall measure manageable but you start to mature the industry. It starts to get good at commissioning projects, at writing contracts to sell things, at managing risks, and so on. And eventually what you do is you taper off that obligation so that the industry can actually start standing on its own feet, and then you’ve got a mature renewable gas industry.
This is exactly what we did in in renewable electricity to support the growth of wind and solar. So over a period of about 25 years, we took that industry from being an emerging, almost like an infant industry. Like it was actually a little baby industry that did not have a lot of sophistication, that didn’t know how to manage risk, how to commission projects, how to order equipment, and so on. And we turned it into one that’s competitive and professional and is now supporting about 40% of Australia’s electricity.
Now, when you are looking at renewable gas you wouldn’t necessarily do a complete cookie-cutter approach of what you did in the electricity sector because there’s a couple of things that are a little bit different in terms about how you move gas around versus how you move electricity around. And also the fact that you would be doing this in a market where there’s not necessarily an overall growth market, because as we keep saying, the overall demand for gas is gonna drop. But the principle is that what underwrites the growth of an industry is some form of guarantee that it will have a market for a while, and that’s what we need to do in renewable gas in order to build it up so that it can take that role that it’s gonna need to do.
Hamish: Maybe the last thing to add on that is that at the moment, New South Wales does have a renewable gas scheme of the kind that we’re recommending to be introduced nationally. That scheme is slated to start next year. Victoria’s also talking about doing a very similar scheme. Very similar, but slightly different.
So what we might end up with is the two biggest states both introducing in the same year similar but different schemes on similar players, sometimes the same players in the economy to drive up renewable gases. Our view is that it would make much more sense if the federal government facilitated a process or introduced their own national scheme, so we don’t have a proliferation of different obligations, some companies having to comply with two different schemes in two different states.
That’s not ideal. It would be far better to have a national scheme that’s straightforward to comply with that could drive development of renewable gases, not just in two states but all over the country.
Alison: That’s a really big lesson out of the electricity sector as well, is that when you have that patchwork of state targets you make things difficult for project developers because you’ve got different rules in different states, different markets emerge in different states, and you actually end up with higher costs because you’re skewing the development towards particular states, regardless of whether that’s actually the best place to do those projects.
And that’s why having a single national scheme is so much better, because what you end up with is an industry that can grow faster and can produce a cheaper product.
Hamish: I’m deeply sympathetic to this point in my former role in an electricity and gas retailer trying to manage all these different state-based schemes to encourage home electrification with different kinds of certificates for different kind of installations. It just makes it impossible to develop products that you can scale nationally.
It means you need vastly more people employed to understand these schemes to submit the paperwork. All of that drives up costs. All of that just makes it harder to deploy the thing that you want to deploy. I think that’s a very important lesson that we could apply to the renewable gas sector.
Ben, let’s turn to gas-powered generation or GPG. Australia has been burning gas to generate electricity in GPG stations for decades. But as gas demand declines, we’re starting to see new problems emerging in the GPG market. Before we get into those step us through why is gas power generation important to backing up renewables?
Ben: So we hear a lot about this in the media, and a lot of the time when gas is invoked as part of the energy transition, people are talking about its role as backing up a renewable grid. So GPG plays a really important role in Australia’s electricity system in the national electricity market and in WA as well on the West Coast.
And the main reason it’s important is because it can run for short periods at times of really high demand when there aren’t enough renewables in the system and there isn’t enough battery storage or whatever else there is to supply the amount of electricity that people are demanding. It’s different to coal because coal takes quite a long time to ramp up and down its capacity and it’s quite expensive to shut down a coal power station, whereas gas power stations can ramp up to full capacity in 10 to 20 minutes and they can operate at quite high capacity for those short periods of time that you need to just provide the little bit of electricity on top to make sure that everyone is getting their demand met.
As we go forward to a more renewable dense grid there will be other technologies that come on board, like we’re seeing batteries come in to play that sort of role. But GPG is really important because it does provide effectively an on-demand source of that flexibility. As long as you’ve got the gas to burn, you can get the electricity from it.
If your battery runs out of charge, you can’t just recharge it in the moment. So in those exceptional moments where there’s not enough electricity going around to, to meet peak demand, GPG will always play a really important role.
Hamish: So we’ve known for a long time that the role of GPG is changing. One of the coolest things I think you did in this report was this analysis of capacity factors, so the percent of the year that gas powered stations are running, and we did that analysis both historically – what’s happened in the last 10 years – and then based on the official projections of the energy market operator, what does the capacity factor look like in the future? Can you step us through how that’s changed in the last few years and how it’s forecast to change in the future?
Ben: So the capacity factor is how much of the time the gas station is running, basically how often it gets turned on. There’s two types of gas plants broadly. There’s what we call mid-merit and then what we call peaking. And the mid-merit is more likely to be running more of the time, so it plays closer to a base load role.
The peaking is genuinely in the sort of exceptional moments of high demand. Peaking have historically had capacity factors somewhere around 15 to 20%, sometimes up to 30%, and mid-merit have been up to 70%, but somewhere between that and 0%. In the last five to 10 years, you’ve seen the capacity factors of those mid-merit more base load gas plants fall very dramatically down towards something like 20 to 30%, and the forecast is for it to fall even lower.
A lot of those gas plants are expected to be retired just to exit, and so they actually won’t be generating anymore. But the ones that are around will be generating much less frequently, more like 10 to 20% capacity factors, and the peaking will go down even further from about 20% to something like 5% in a lot of cases.
Hamish: I thought it was so interesting even just in the last few days, there was an article about, Snowy Hydro’s Kurri gas-powered station, the Hunter Power Project which is a federal government-funded project. The point was to provide peaking power. It’s been finished, so it’s ready to go, but they haven’t commissioned it.
And in part, it’s because, in the words of the Snowy CEO, the market just doesn’t need it. If they could earn money by switching on and generating power, they would be doing it. But actually the market’s really well supplied at the moment, and so instead it’s sitting there idle, doing absolutely nothing.
And we’ve seen in the last couple of years, the latest gas power stations that have opened have run really low capacity factors, and I think it just illustrates pretty starkly that even in a very high renewable grid, we don’t need a huge amount of gas-powered backup to supplement the renewables.
And that makes it really hard to build a business case to invest in new GPG, which is potentially a risk if we think that we do need GPG as backup.
Ben: Exactly, Hamish. I think the hard thing with GPG is that because it runs so much less frequently than something like a solar farm or a coal station, when it is running, it has to charge really high prices. They’re still expensive to build. And so in order for it to be worth your salt to actually build a gas-powered generation station, your forecasts of how much you’re going to be earning when you’re actually running need to be really high.
So it’s a little bit of a catch-22. We want to use less gas because, it reduces the emissions and it also means we’re using more renewables, which is cheaper. But it means that when we do need to use gas, in order for those gas-powered generation stations to make their money back, they need to be charging really high prices.
So in those times where we do need it, it looks like it will be really expensive. And if they can’t get those prices because there’s competition from other sources of flexibility like batteries, which can provide at effectively zero marginal cost, they won’t be able to make that money back. And suddenly it doesn’t look like it’s a very good idea to invest in these new gas-powered generation stations.
Hamish: So this is one of the big questions: how much gas power generation do we actually need? In the report, we basically took the energy market operator’s integrated system plan as the best estimate of how much GPG the system actually needs, and we got a bit of critique about whether that is the best estimate to use.
We also do make the argument in the report that the integrated systems plan itself might overestimate the amount of gas power generation that the national electricity market needs. We know that there’s alternative kinds of dispatchable power. There’s batteries, there’s pumped hydro.
Alison, can you set out the argument that the amount of gas power generation that we need in the electricity system might actually be less than we think?
Alison: In the report we were using the market operator’s estimate, which is that we need about 15 gigawatts of gas power generation by about 2040. That’s around 20 to 30 large-ish gas power stations, which is more than we’ve got today. A lot of those are gonna have to be built over the next couple of years some of them to replace old ones and some of them for that new thing.
Now, in a couple of weeks’ time, we’re going to get a revised estimate from the market operator, which could well be different to what we said. And this is one of the things that I think when you look back over the forecasts of the amount of gas power generation every year, it’s bounced around all over the place, and that’s because the technology that’s available to play the role that gas plays has been changing so quickly.
And in particular, the thing that has been changing has been batteries. One of the trends that we’ve seen in the last couple of quarters is that batteries are taking over gas’ traditional role of supplying electricity at the evening peak. And , as You were saying, Ben, that’s when they used to make their money, and batteries are now taking that money off them.
And so what is happening is gas generation is going through a transition from something that got used every day to something that gets used occasionally. And this actually creates a second question of how it’s gonna get its gas. If you’re using gas every day in your gas power generator, then all you need is a pipeline that goes pa-past your front door, and you pull your gas out of that when you need it.
If you’re only using gas occasionally, and if, as we were saying before, that pipeline network is starting to be decommissioned, there is a real question about how you make sure you get your gas on the days that you need it. You will have to store gas more, for example. And, also the way that we contract for gas needs to be different as well.
And one of the things we point out in the report is the way we plan the electricity system at the moment is we identify that there’s a need for gas power generation, but the thing that isn’t included is whether it can get the fuel. And one of the things we called for in the report is to start co-planning the electricity and the gas system together, so that when you’re optimizing for the amount of gas generation you have, what you’re actually optimizing for is fuel availability as well as just when is it going to run.
Because, a gas power generator can– your model can tell you theoretically it’s gonna run this many days a year, but if it can’t actually get the gas, it’s not actually gonna run. So the real risk that you’ve got is that you overbuild on one side of the equation and you underbuild on the other.
And to get that we actually need to start looking at the energy system as a single energy system and not a gas system and an electricity system
Hamish: I think something that came out really strongly for me in this report that gas is just such a physical system, and we need to really think about it in, in physical terms. We’re digging the gas out of the ground on the East Coast, mostly in Central Queensland. It’s being burned mostly in Melbourne and Victoria, and moving it from one place to the other is a real challenge.
In places like South Australia, most of the gas power stations are all in the same spot in Torrens Island near Adelaide. That’s, pretty close to a long transmission line. In places like Newcastle, where there’s a few gas power stations, that’s the very end of the gas transmission line. So you’ve got to move the gas from Queensland into central South Australia, back down to Sydney, and then back up to Newcastle.
It’s a completely different equation in terms of how easy it is to get gas to those two locations. And so introducing that consideration of where is the physical gas gonna come from might actually change the equation about where you think it makes the most sense to build these power stations.
Okay, so we’ve talked about two emerging problems for gas-powered generators. One of them is this, question about access to physical gas and how that affects how much you build and where you build it. The other one is this point that y-y-you made, Ben, that because these plants are running so infrequently, it’s difficult to build a business case, it’s difficult to get finance.
And so we might not build the stuff that we do need not because we don’t need it, but because the business case is tricky. We’ve put forward a recommendation about how to overcome that financing barrier.
Alison, we put forward a recommendation to use this thing called the Electricity Services Entry Mechanism to solve the gas financing problem. The ESEM is a proposal. It doesn’t exist at the moment but it came out of a major review of the wholesale electricity market last year. We think that there’s scope to use the ESEM to solve the gas financing problem.
Can you step through what is the ESEM and why do we think it can solve this problem?
Alison: The ESEM was developed through this process of review because one of the things about the overall technology change in the electricity system means that increasingly the whole system is dominated by assets that cost a lot to build but have uncertain output and uncertain demand for their product.
If you wanna finance one of those assets, you need someone to make a long-term commitment to buying your output. And at the moment, most buyers of electricity are happy to commit for maybe five years, but they’re not really happy to commit for 10. And it’s hard for people to borrow enough money to finance the asset if they’ve only really got five years of certainty over their revenue.
What the ESEM is meant to do is to help solve this problem by providing kind of a buyer of last resort in the long term, but letting the private sector continue to be the person who’s taking the electricity in the short term. It’s pretty critical that something like the ESEM is set up because without it, we’re actually not gonna be able to build any new assets in the electricity market unless they’re directly subsidized by government.
And that’s gonna make the power system less reliable and more expensive. The ESEM is being designed at the moment. One of the really critical questions that has come up about it is whether or not it should include gas or whether it should just be limited to new renewable generation.
It’s our view that as long as you put some kind of constraint on the emissions from the gas power generation, there is no reason why the ESEM should not include the gas. And as we explored in the last report that the team did last year there are many different ways that you can constrain emissions in the electricity sector, and that’s a necessary thing in order to give the right signal to build the right mix of gas and non-gas generation in the future.
As long as you get that right, there’s no reason why the Electricity Services Entry Mechanism shouldn’t help to underwrite gas where we do need that gas in the system.
Hamish: Alison, Ben, we’ve covered a huge amount of ground today. Maybe just before we wrap, I might ask, what is one thing that you would hope people might take away from reading this report? Ben.
Ben: Yeah, I’m happy to go first. I think the biggest thing that came from doing such a comprehensive and wide-ranging report was just a very nuanced appreciation of the role that gas plays in Australia. It has so much to do with so many things, not just in your households, but, across the economy in the thrumming electricity systems behind all of us, and also as a major part of our relationships with overseas trade partners and allies, which we’ve seen come up so much during this last crisis.
I think the main thing I would want to take away is, yes, it plays an important role, but it also is a really big contributor to our emissions target. 23% of all of our emissions are gas-related, so we do need to take seriously the task of finding replacements for all of the roles that gas plays in Australia to continue to live the great lives that we do and to continue to prosper as a country and to continue to look after each other and the rest of the world.
Things like LNG generate 40% of the emissions, and we want to make sure that we’re getting a good return for all of the disbenefits of that.
Alison: I think the thing that I felt was really important about this report was to move on from this phrase of gas is an important part of the transition to actually acknowledging that gas is going through a transition. The energy transition is a transition for gas as well, and that brings its own problems, but it also brings opportunities for things like renewable gas, for things like electrification.
So for me, the thing that’s important is that we actually start acknowledging that there’s a transition on for gas as well, and then start dealing with that properly rather than using this sort of throwaway slogan line about it being an important part of the transition
Hamish: Okay, that was gonna be mine. I was gonna steal your line, Alison, that important does not mean large. Important means critical. Maybe I’ll do instead that, gas generates 4% of electricity in the NEM. It’s not a lot. We actually don’t need a lot of gas to back up renewables.
And I think if you are an average punter watching the news and you’re seeing premiers and politicians talk about how it’s so important to invest in vast new gas infrastructure because gas is critical to backing up renewables, that sort of logically doesn’t flow. It is really important to backing up renewables, but we don’t need a huge amount of gas to do that job.
We need a lot less today than we did 10 years ago, and we’ll need a lot less in 10 years than we do t-today.
Alison, Ben, thank you so much for your time.
Ben: Thanks Hamish
Hamish: The report Out of gas: Managing the decline of gas in Australia is now available to read on the Grattan website if you’d like to continue reading. Thanks for listening to the Grattan Podcast.
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