In the third and final instalment of our Blog series on energy cost increases, Tennant Reed investigates the options available to government and industry in responding to the escalating costs of electricity and gas.
Businesses and household across eastern and southern Australia are starting to see a new wave of energy cost increases. These will be painful for many, and a serious blow to the competitiveness of some trade-exposed industries. Many want to know: what’s happening? Why is it happening? And what can we do about it?
Here, in the final part of our series of three Blog posts, we address part three of the equation: What can we do about it?
- Increasing supply and improved efficiency could reduce gas price pressure and improve security, but prices of $8-10 per Gigajoule (GJ) are likely to become the new normal.
- Efficiency, improved gas supply and unlocking RET investment could modestly help electricity prices in the near term, but major action is needed across multiple elements of market design to help deliver a reliable, affordable electricity system over the longer term.
Prices for electricity and gas have gone up a long way. What can we do about it?
Let’s look at gas first. The current pressure on prices is coming from surging demand and supply that isn’t keeping up. We are likely to see more demand from gas-fired electricity generators. Two steps seem obvious: encourage lower demand through energy productivity and fuel-switching away from gas; and encourage greater supply through easier production and perhaps an import terminal. These all have some potential to ease the current tightness in our market, with benefits for price and ability to get workable supply contracts.
There are many ways to use gas more efficiently in homes and businesses; high prices will push some to invest in productivity, and policies like New South Wales’ Energy Savings Scheme can assist others to do so.
Gas is an essential feedstock for basic chemicals production, but for other applications in heat and power it is merely one option among many; substitution to grid electricity, distributed energy or other sources is possible and will make sense for some consumers, particularly households. Eastern Australia has substantial identified gas reserves that could be developed if blanket bans on coal seam gas and fracking were replaced with firm regulation of water impacts and fugitive emissions. And an import terminal could ensure access to large new volumes of gas at the going international rate in a world awash with supply.
But useful as they are, there are limits on what these steps can achieve. Domestic supply and demand are significant price determinants now, but a sustained recovery in global oil prices would lift East Asian gas prices and restore the relevance of export parity prices. The rise in the underlying cost of producing local gas puts a floor under sustainable prices. Large reductions in domestic gas demand would also put pressure on gas network infrastructure to charge higher prices to recover their costs on lower volumes; beyond a certain point, either commercial and regulated network assets lose their value, or higher network charges outweigh lower wholesale prices (it is important to note that a ‘death spiral’ where reduced demand raises network charges, leading to more reduced demand and more price rises, is much more plausible for gas networks than for electricity).
Higher investment in local production will need investors with deep pockets, which is more likely if and when global oil prices rise – which will in turn support high prices here. A Liquefied Natural Gas import terminal would cost several hundred million dollars, which would need to be recovered from consumers, and would forge an even tighter link to international prices.
All told it seems clear that the old $4 per GJ gas market is gone forever in Australia. The steps above could relieve short-term price pressure, and certainly make it much easier to get a competitive local market and secure supply. But with the International Energy Agency projecting a rebound in international oil and gas prices over the next few years under all scenarios, gas at $8-10 per GJ or more seems likely to become the new normal.
The likelihood of high gas prices impacts efforts to contain electricity prices too. Gas plays important roles in baseload supply, in meeting peak demand, and in stabilising the system. In the medium term those roles will grow as old coal plants retire and renewable energy generation increases. Sensible steps to contain gas price rises and bolster supply will have benefits for electricity.
In the short term the key influence on electricity prices is the balance of supply and demand. In the longer term, prices will have to reflect the underlying cost of renewing and sustaining a reliable electricity system. What can we do on each front?
As with gas, electricity demand can be moderated by efficiency and productivity. Price response will deliver some of this; many people were surprised by how strongly consumers responded to the last major burst of electricity price hikes in 2010-13. Further reductions can be driven through well-designed policies, including State efficiency schemes, support for audits, product standards and more, that have benefits both for direct participants and the wider market.
However, it is also possible that other factors increase electricity demand, including through fuel switching from gas to electricity if supply challenges persist, or through growing use of electric vehicles and plug-in hybrids. Efficiency measures could still leave demand lower than it otherwise would be, but are not a complete solution.
On the supply side, some mothballed generation capacity can be returned to service, and new generation can help. But plants like Hazelwood and Northern are retiring for strong reasons, including age and reinvestment requirements, and the physical and financial difficulties inflexible generators face in a market marked by frequent oversupply and occasional shortage.
Substantial new renewable capacity is planned under the Commonwealth RET, though investment is flowing painfully slowly. Unblocking it would put downward pressure on wholesale prices as well as RET costs. Further renewable capacity driven by various State proposals could increase this pressure. But there are limits to the suppression of prices through cramming in extra supply, since this eventually pushes out vulnerable incumbents and returns prices to an equilibrium.
Looking to the longer term, it seems clear that technology, market forces and climate goals are going to make conventional coal and, eventually, gas power unviable, and bring on lots of renewables. But while fossils may be becoming uneconomical, renewables remain variable and intermittent. Low-cost ways must be found to turn an intermittent abundance of energy into a dependable resource when we need it. And the underlying cost of generating electricity needs to be pushed as low as possible if we are to be competitive.
The emerging electricity system depends on flexibility and multiple reforms must encourage and reward that flexibility. Demand side response can reduce demand at critical periods to deliver several energy services and limit wholesale prices. Energy storage can time-shift supply, stabilise the system and substitute for investment in peak capacity for generation or networks. Technologically and geographically diverse generation and stronger interconnections can reduce the impact of intermittency.
There are several ways of encouraging each of these steps, and it is critical that COAG Energy Ministers agree a way forward in each area.
Recent projections suggest the levelised cost of all Australian options for new-build generation is at least twice to three times the typical market prices of the past two decades. Contracted prices for actual new builds in Australia, and even more so overseas, suggest we could do much better than this.
The chart below combines recent Australian projections for new build costs (the striped green-and-gold columns) with recently contracted prices for new builds overseas (the solid blue columns) and in Australia (solid green). This data suggests that real Australian costs are already lower than projections, but that other countries have achieved much lower cost, particularly for solar.
While technology costs for solar, wind and batteries are being driven down every year, urgent work is needed to determine whether Australia faces structurally higher costs to build new energy than other economies – and if so, how we can close the gap. Finance costs and construction productivity seem an important focus for improvement.
What has been your recent experience with energy costs in your business? Do you have a view on the best policy responses you would like to see from government and industry? Please share your thoughts and experiences by leaving a comment below.
Latest posts by Tennant Reed (see all)
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- What will new energy policies actually do? - 16 June, 2017