What would it take to get new coal generators built?

Power prices are high and the reliability of electricity supply is under question, with serious implications for the continuity and competitiveness of businesses across Eastern Australia. Problems in the gas market are a big contributor, but so is the tightness of the electricity market. More than five gigawatts of coal fired electricity generation has closed in recent years – of which Victoria’s Hazelwood was just over a quarter. Electricity demand has stopped falling, and new all-time peak demand records were set last summer. More electricity supply would be very helpful to ensure the lights stay on when we need them.

Where will that new supply come from? There is much debate over the merits of coal, gas and renewables; in a previous post I outlined the challenges for investment in a hypothetical new coal project in particular. The Finkel Review proposed the concept of a Clean Energy Target (CET) to incentivise new generation. Unlike the current Renewable Energy Target, a CET would be open to all low-emissions electricity technologies, providing support proportionate to their cleanliness; if well designed, such a scheme would allow coal, gas and renewables to compete on their merits in a more functional set of electricity markets.

Some people are worried that a CET would not give fair consideration to new coal-fired generators, or are certain that we need new coal and want to see it guaranteed. There have been suggestions that government contracts to underpin new coal-fired power stations could complement a CET. What would such contracts look like, and would they be a good idea?

In a new working paper released today I go through these questions in depth. Many governments around the world – including most recently the Victorian Government – have used ‘Contracts for Difference’ (CfD) to attract new generators. A CfD guarantees that if the revenue a generator earns from selling power and any clean energy certificates is below an agreed ‘strike price’, the government will pay the difference; and if the generator’s revenue is above the strike price, they will refund the difference to the government. With some measure of protection against power market risks they have no control over, the main risk facing a project proponent is well within their control: whether they can deliver and run a power station at the cost they expect. Lower risk reassures financiers and enables cheaper project finance. And if CfDs are awarded through a competitive reverse auction, bidders will offer the lowest strike price they think they can be viable at, and the process should produce cheaper projects and cheaper power.

There are drawbacks to a CfD model. Risk is not being reduced, but transferred to government, which may wind up with significant costs to pass on to taxpayers or energy users.  And in defining its contract requirements, government is effectively designing part of the future energy system – a task it may not do well, and which potentially impacts existing assets and discourages other private investment. These may not be reasons to rule out CfDs, but they certainly suggest we should look very carefully before leaping.

CfDs to underpin new coal generators look particularly risky.

First, price and volume risk. New coal looks relatively expensive on most estimates. The lowest cost estimates make assumptions that would be hard to achieve, like 90% utilisation rates in an often-oversupplied market where existing coal generators average 65% and falling, or far-below-market prices for fuel when the reach of the coal export rail systems is wider than ever. A CfD might need to guarantee new coal a strike price around $70-80 per megawatt hour (MWh), twice the historic average wholesale electricity price and well above the costs of new wind and solar generators. The contract would need to allow the new coal generator to rely heavily on government payments to keep it dispatching in the electricity market against competition from existing lower-cost coal plants. The latter would likely retire faster as a combination of renewables and subsidised new coal devoured their shrinking base load market.

Second, carbon risk. New coal plants burn hotter and at higher pressures than old coal plants, producing somewhat lower greenhouse gas emissions: perhaps 700-773kg carbon dioxide (CO2) per MWh for a new ‘High Efficiency Low Emissions’ (HELE) black coal plant, versus around 900kg CO2/MWh for an existing black coal plant like NSW’s Bayswater.  But this is still well above the emissions of new combined cycle gas generators (370kg CO2/MWh) and wind or solar (0kg CO2/MWh). With all Australian governments targeting deep emissions cuts over the next few decades, government policies to achieve those cuts are a big risk to high emissions coal plants. A CfD would need to provide the new generator with an absolute guarantee against any carbon cost or constraint imposed by any level of government – potentially a very expensive promise over the likely 30-year life of the contract.

Policy, market and technological changes could see these risks play out in many different ways. But across multiple scenarios considered in the new working paper, a CfD for new coal looks significantly more expensive for government than an equivalent contract for renewables or gas generators, even if the price of gas remains high. The costs of ‘firming’ variable renewables – with energy storage, demand response, or dispatchable backup like gas – are real, though they are hard to estimate reliably because the state of the market and the costs of the technologies involved are changing so rapidly. These costs don’t apply to gas, and even for renewables they would have to be quite high before they would make a coal CfD relatively cheaper.

In short, a new coal CfD would have to be so generous to investors that it is hard to believe governments will offer it – or keep honouring it over thirty years. But that is hardly the end of the story for coal generation in Australia. A recent report by a German energy think-tank lays out how coal plants can be upgraded to ramp up and down more easily and rapidly, allowing them to compete as backup and peaking plants in a growing market for flexibility, rather than being trapped in a shrinking market for always-on base load. There are many competitors to provide that flexibility, including gas, pumped hydro, demand response or dispatchable renewables. What coal needs to get its chance is not a sweetheart contract for difference, but a durable bipartisan framework for energy and climate policy that puts a value on reliability and encourages low emissions without barring coal. A CET, combined with another big Finkel Review recommendation, the Generator Reliability Obligation, could fit the bill. New or upgraded coal generators face no penalty ever under a CET – and they can make money selling backup services to renewable generators who need to meet their reliability obligation. Despite the worries of coal backers, a CET may be their best hope.

See the full working paper, Will a contract make the difference? for more. What do you think the options for new electricity generation are? Let us know in the comments section below.

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Tennant is Principal National Adviser – Public Policy at Ai Group. He has worked heavily on climate and energy issues, advising Ai Group’s Leaders’ Group on Energy and Climate Policy and developing reports on natural gas supply, energy prices and energy efficiency. He also works on a range of issues related to manufacturing and innovation. Previously he was an adviser in the Department of Prime Minister and Cabinet, working on fiscal policy, stimulus and infrastructure.

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