Issue 70, February 2011
Welcome to the second issue for 2011 with the news that last year this newsletter achieved an average page view tally of 2,932 per month, peaking at 3,792 in October. Regular readers are no doubt aware that the newsletter is also now supplemented with the This is Power blog on this site. This issue deals with the continuing saga of New South Wales power sector ownership, the national decarbonisation challenge, which is now bigger, and power price concerns among other issues.
The March election in New South Wales is set, on opinion polls and pundit analysis, to bring the ALP State government crashing down – on some estimates delivering the Coalition 62 to 64 seats in the 93-seat Legislative Assembly versus 20 to 22 for Labor, the rest held by the Greens (perhaps two) and independents. This implies that the Liberals and Nationals may govern for at least most of this decade, raising a raft of questions about how electricity policy will change in Australia’s largest supply/demand region.
Coalition leader Barry O’Farrell has already committed to holding a judicial inquiry in to the controversial and half-completed Labor “gen-trader” privatisation process immediately after winning office and to not putting up for sale the quartet of State-owned network businesses.
This leaves a large question mark over the approach a Coalition government will take to ownership of Macquarie Generation (whether the business or its power output) and of the balance of Delta Electricity not caught up in the “gen-trader” deals announced in December (which saw most of the Delta and Eraring Energy board members resign).
There are at least a dozen other policy areas an incoming government will need to address that will materially affect the NSW and east coast power supply environment, including the State’s approach to regulation of residential electricity costs.
The behaviour of the Keneally government through January and February has reinforced the view of a large number of political observers that it, and other Labor government across Australia and the Federal government, have developed a fatal attraction for spin over good process management in the past decade, leading to a near-death experience for Julia Gillard at the federal poll and defeats already for the ALP in Western Australia and Victoria.
Keneally’s spinning reached perhaps its nadir during the NSW Legislative Council inquiry in to the “gen-trader” sales when Hydro Aluminium Kurri Kurri executives – whose contract to renew purchases of power for their Hunter Valley plant from Delta Electricity had been abrogated at the last minute by the government – were confronted while giving evidence by a media statement from the premier, released minutes earlier, saying she would “encourage” Macquarie Generation and the company to “work quickly towards a mutually beneficial agreement,” vowing to “do everything in my power” to see a deal was reached.
Kurri Kurri managers told the inquiry that a $130 million expansion of the smelter could not proceed until a contract was signed to give effect to a heads of agreement arrangement its board and Delta’s had signed in Oslo last July.
The operation employs 600 people and claims another 2,500 workers as indirect beneficiaries, making it a critical employer in the area.
The managers said that they had written to the State treasurer, the Treasury Department and the premier over 12 months about their concerns over the impact of the “gen-trader” sales on their plans and “have had no response at all,” including no advance notice of Keneally’s media statement.
The failure of of the NSW government to complete the sale of generation production has left the State with a half-cooked scramble of private and public enterprises where the taxpayer appears to be the biggest loser.
This is the view of a former senior figure in electricity supply who has contacted me to warn of the dangers of the process that are not getting media attention.
At face value, he says, the sale of the retail businesses appears satisfactory. The price per customer is comparable to other sales and acceptable given the still-fragile state of financial markets.
However, it needs to be understood that retailers are counter-parties for generators.
“The privatisation experience,” he says, “has been a truly miserable one for merchant generators without a captive retail base. Fortunes were lost by over-excited American and European utilities buying in to the Latrobe Valley without also buying retailers.
“Now the partial NSW auction has created exactly the same conditions for the remaining power generation assets. The entire load is now substantially controlled by origin Energy and TRUenergy, leaving the taxpayer-owned gencos exposed to the extreme volatility of spot prices.
“The original justification for this sale was to reduce spot market risk and also to shed the requirement for expensive trading desks dealing in some of the most esoteric tradeable financial derivatives imaginable.
“But the sale of the retailers without sale of the gencos continues these risks and arguably makes them worse.
“Previously, NSW taxpayers had a balanced portfolio with the generators offset by the retailers, using a web of co-insurance and hedging contracts to largely eliminate energy market risk.
“Now the position is dangerously lopsided, with exposure to the perilous spot market – and to trading errors.”
He points out that the NSW government imposed the co-insurance and hedging requirements on State-owned generators and retailers in the late 1990s after the billion dollar Pacific Power/Pacificorp dispute.
Now, he asserts, the remaining generation interests have been made much more perilous and will require ongoing sophisticated management with extensive trading expertise. “Moreover, a generator without a certainty of load is essentially unbankable, meaning that it is largely financed by equity rather than cheaper debt.”
He believes the the outcome of the sales, as it stands now, will show up in higher financing costs and possible future trading “blow-ups.”
“Of course,” he adds, “these generators can enter the retail market themselves. They can recruit expensive marketers and retain elite advertising agencies. They can build call centres and hire an army of door knockers. But this will require money to be invested – exactly what the NSW government was hoping to avoid.”
As well, he points out, the taxpayer-owned generators with “gen-trader” contracts will need to service them. “They will be servicing their direct competitors in a vicious and cut throat market. Chinese walls look like a necessity to ensure that the gen-trader offtakers are treated fairly. In the process more cost and complexity will be layered on to the NSW generators.”
In their determination to protect their political posteriors, State governments, other than in Victoria, continue to dodge and weave on the issue of retail power price deregulation.
The Council of Australian Governments meeting in Canberra on 13 February produced a fresh set of weasel words while government leaders apparently re-endorsed the plan to lift price controls where the market has effective competition. Only Victoria, under the Bracks/Brumby government, has been prepared to take the necessary step in market reform.
The COAG communique says the leaders “note future policy decisions in this area are likely to have regard to related activity by the Federal government to explore options for the implementation of a carbon price.”
This is a very convoluted way of saying: “We know that the carbon price needed this decade to meet abatement targets will be high and we want to cling to a way of protecting ourselves from voter anger.”
The next step in the slower-than-slow process is that there will be assessments of the retail electricity and gas markets in the ACT (in June this year), New South Wales (next year) and Queensland (in 2013).
Meanwhile the delays in the retail price deregulation process have come under fire in the latest paper on market issues produced by AGL Energy. Written by the company’s chief economist, Paul Simshauser, who is also finance professor at the Griffith University Business School and chairman of Loy Yang Power, and his colleague Kay Laochumnanvanit, it seeks to highlight the risks that arise when attempts are made to suppress necessary power price rises reaching consumers. (The paper can be found on the AGL Energy website.)
“Given the sheer complexity of the supply chain, the notion of non-trivial error and its impacts are far more than a theoretical possibility,” the authors say.
As they comment, progress in retail market reform on the east coast has been “painfully slow” despite the introduction of the wholesale energy market being hailed internationally as a success.
“Regions retaining regulation run the risk of driving over-consumption, inadequate competition, merchant generation investment blackout and, following any price correction, a media assault.”
Things are not helped, they add, by the “glacial pace” of regulatory price resets.
The role of the media in ramping up emotions about power price rises is underlined by the AGL pair pointing out that there has been a 140 per cent increase in media coverage of the issue in NSW in two years – in the wake of price rises following the Australian Energy Regulator decisions on network capex and opex.
As Simshauser and his team have been at the forefront of highlighting the impending large rise in customers unable to meet the rising costs of electricity – in an early paper, they predict that there will be about 340,000 households in “fuel poverty” in NSW and Queensland alone by 2015, when retail prices are predicted to be double what they were in 2008-09 – they can’t be accused of ignoring the impact of the issue, but they point out: “Politicians need to comprehend that price regulation is an inappropriate and blunt instrument for dealing with hardship issues.”
Where there is effective competition for customers and appropriate hardship policies in place, Simshauser and Laochumnanvanit say, “the reasons for retail price regulation no longer exist.”
International credit ratings agency Fitch Ratings predicts that up to $25 billion worth of low-emission and renewable energy generation will be developed in Australia between now and 2016 if a carbon price is introduced.
At the same time, it warns that Victorian merchant generators in particular face significant refinancing next year and their task could be “tough should capital market conclude that a carbon price will result in stranded or economically impaired plant.”
Lack of government compensation for generators that experience losses from the introduction of a carbon price would be a big factor in refinancing, Fitch points out.
The Victorian generators, it adds, collectively have $2.4 billion in project finance bank debt maturing in 2012.
Fitch believes that “there is a likelihood” of the Federal government at least partially compensating the senior lenders to any generators that undergo forced decommissioning as a result of the introduction of a carbon price.
It expects most new generation to be developed in Victoria, New South Wales and Queensland. It projects a $10 billion outlay on open-cycle gas, combined cycle gas and wind farms in NSW and about $8 billion in Victoria, but says that the cumulative outlays will be about $7 billion lower if a carbon price is not introduced.
Fitch splits the outlay in to $3.4 billion on OCGT plant (peaking power), $11.4 billion on CCGT (baseload) and $10.5 billion on wind farms, driven by the requirements of the Federal government’s renewable energy target.
The agency sees Victoria leading in wind development between 2011 and 2015, with 2,335MW of new plant being commissioned, followed by South Australia (1,132MW), NSW (923MW) and Tasmania (568MW).
Most of the 341MW of renewable development in Queensland is expected to be provided by solar plant and biomass energy.
Looking at networks, and recent regulatory determinations, Fitch reports that outlays on distribution capex will exceed $6 billion in each financial year from 2010-11 to 2013-14 and transmission expenditure will exceed $2 billion in each year.
It attributes three causes to the huge network outlays: continuing high energy and maximum demand growth caused by population increases and the rise in average household electricity consumption, continued need to reinforce and upgrade transmission capacity and the requirement on all service providers to replace aged and obsolete assets.
Fitch Ratings agency is warning that New South Wales generators may run in to coal price problems in the first half of this decade, with consequences for east coast wholesale energy market price volatility.
The agency notes that the Keneally government, which is an unbackable favourite to lose office in March, has been undertaking the development of the Cobbora coal mine to meet the needs of State-owned generators.
The mine is supposed to be commissioned in 2015 and Cobbora is expected to enter in to long-term supply contracts with Macquarie Generation, Eraring Energy and Delta Electricity at prices below the market.
However, Fitch points out, as existing coal supply contracts start running out, the generators face the risk of coal price increases.
“This may translate in to pool price volatility depending on the generators’ coal procurement strategy. Moreover, the price and target commencement date of supplies from Cobbora are subject to renegotiation in certain circumstances.”
What Fitch doesn’t say is that the turmoil on the Eraring and Delta boards as a result of a mass walkout of directors over the Keneally/Roozendaal privatisation process will continue this year as it is almost certain an incoming O’Farrell government will turf out the replacement directors appointed to shove through the “gen-trader” sales.
None of this bodes any good for governance in these organisations in the short term – and the Cobbora development itself is likely to be caught up in the promised judicial inquiry in to the “gen-trader” deals if the Coalition win office on 26 March.
Fitch Ratings has also published its 2011 review of Australian oil and gas – and the agency predicts that upstream projects, mainly LNG developments, face increased delays and upward cost pressures in 2011.
These project, Fitch points out, are competing not just amongst themselves, but also with other large Australian resources and infrastructure developments.
“Delays and cost pressures will arise from skilled labor shortages in Australia adding to labor costs along with the cost and availability of materials and equipment. Reconstruction work required in the flooded areas of Queensland and Victoria will also add to these pressures.”
(The report was written before north Queensland was ravaged by a cyclone.)
The good news for Australian LNG developers is that Fitch Ratings sees Asian demand for gas recovering further in 2011 and it predicts an increase in Australian exports because of continued demand from Japan, South Korea and Taiwan, emerging strong demand in China, supply bottlenecks impacting on Indonesian production, gas supply shortages in Malaysia, the emergence of India as a buyer of local supplies and the emergence of a new group of net importers in south-east Asia, including Singapore, Thailand, Vietnam and the Philippines.
There is a preference for buying Australian supplies, it notes, because of this country’s reputation for reliable delivery.
Fitch Ratings also projects strong cost issues for gas explorers and developers in Australia.
The agency points to the need to explore relatively more remote and deep offshore fields, with increased technical challenges and substantial extraction costs, and the impact on projects based on coal seam gas onshore of a difficult consenting process across many stakeholders, including water-related costs and the higher costs for pipelines and liquefaction plants.
One of the myriad of problems affecting the death-spiral Keneally government, according to a report in The Australian, is the discovery that its panicked slashing of its rooftop solar power subsidy scheme to save costs missed the mark by half a billion dollars.
The Labor scheme, introduced at the start of last year and severely cut back by October as it was rushed by householders, initially offered them a tariff of 60 cents per kilowatt hour for all the production of their solar arrays, not just what they consumed.
Confronted with the fact that demand for this over-generous scheme was going to add some $4 billion to NSW household’s power bills between now and 2016 as the cost was smeared across all residential consumers, Keneally slashed the feed-in tariff to 20 cents/kWh and capped the scheme at 300 MW.
This would still leave householders as a whole paying $1.5 billion over the six-year life of the program, she admitted.
According to The Australian, however, the State government’s decision to give consumers 24 hours to sign up to the scheme after the cuts were announced and those who had already ordered PV panels 21 days to register has led to the capacity being pushed up to 320MW and the cost to State householders shoved up to $2 billion.
The degree of difficulty for Australia in meeting the bipartisan decarbonisation target for the decade’s end – reducing greenhouse gas emissions to five per cent below 2000 levels – has been increased by the latest official projections.
The latest projections released by Climate Change Minister Greg Combet indicate that emissions in 2020 will be 24 per cent above 2000 levels.
This will require abatement of 160 million tonnes annually by the end of the decade, equivalent to 75 per cent of the greenhouse gases released today in producing electricity in Australia.
The previous official target was 144 million tonnes annually, itself higher than the initial goal of 139 million tonnes used by the Rudd government in developing the aim.
Announcing the latest situation, Combet claimed that there is a risk of new coal-fired power stations being built unless a carbon price is introduced and its lack could also affect the other government target of delivering 20 per cent of power consumption from renewable energy by 2020.
This ignores the fact that obtaining bank finance for a large new coal-fired power station in Australia today is considered by most observers to be impossible and that the biggest impediment to the RET being achieved is the botch the Rudd government made of the initial scheme, resulting in the renewable energy certificate market declining substantially, a slump from which it has yet to recover.
The three key points of the Department of Climate Change report are:
(1) Australia remains on track to meet its Kyoto protocol target of limiting emissions to 108 per cent of 1990 levels between 2008 and 2012, with emissions expected to average 582 million tonnes a year.
(2) On present trends, emissions are expected to reach 690 Mt a year by 2020.
(3) If the Gillard government adopts the much higher target being pressed on it by the Greens in the negotiations for their parliamentary support for a carbon price, the amount of abatement would need to rise to 272 Mt annually in 2020 (for a 25 per cent target).
Electricity generation accounted for 36 per cent of emissions in 2009, according to the department, with direct fuel combustion contributing 15 per cent, transport 14 per cent and agriculture plus deforestation and forestry delivering 20 per cent. Fugitive emissions from mines and pipelines contributed seven per cent and waste management processes three per cent.
The department says emissions from electricity generation are likely to grow at six per cent between 2010 and 2020 – much lower than the rate of increase of 15 per cent between 2000 and 2010.
This is attributed to the impact of the RET, energy efficiency measures and lower power station emissions intensity.
This, of course, also makes a nonsense of Combet’s claim that one of the factors in the overall increase of emissions to 2020 will be new coal-fired power stations.
One of the contributors to higher emissions at the decade’s end, says his department, will be increased LNG production, adding nine million tonnes a year.
The DCC report also notes that emissions from industrial processes will reach 31 Mt a year in the “Kyoto period” (2008-12) and rise to 40 Mt by the end of the decade, with metals production and the chemicals industry each contributing an extra 4 Mt annually.
The department estimates that the RET will deliver almost 30 million tonnes of abatement by 2020, most of it from wind farm development. It claims the national strategy on energy efficiency will contribute 42 Mt.
The department’s modelling has assumed that GDP will grow by an average of three per cent this decade and population will rise by an average of 1.4 per cent annually.
While it expects brown coal consumption to be static at 70 million tonnes a year over the decade – which assumes that no Victorian power stations will be forced in to decommissioning by government carbon policy – it projects that underground black coal mining output will rise from 115 Mt a year in 2010 to 200 Mt at the decade’s end and that surface mining production will increase from 385 Mt annually now to 550 Mt in 2020.
(The electricity industry’s use of black coal in NSW and Queensland at present is about 50 Mt a year.)
Even allowing for domestic use of black coal in power stations increasing to 60 Mt a year by 2020, these figures demonstrate that burning of Australian coal overseas will rise by 240 Mt a year by the decade’s end.
Or to put it another way, Australia will be inflicting economic pain on itself at home to help pursue decarbonisation globally and working hard to increase emissions internationally by selling a lot more coal overseas.
Ross Garnaut has joined Bob Brown in playing the catastrophe card in a renewed effort to persuade Australians to support a price on carbon dioxide emissions.
Our position as one of the world’s largest emitters per head of population makes it morally imperative for us to embrace carbon pricing is their argument in a nutshell.
If we don’t, we must expect major floods and savage cyclones to happen more often.
“You’ve seen nothing yet,” threatened Garnaut as Cyclone Yasi bore down on north Queensland.
Using per capita emissions is one of the tricks of the trade for the decarbonisation boosters.
It is intended to make ordinary Australians sufficiently uneasy about our role in global warming to embrace the Gillard/Brown carbon policy – although we don’t yet know in detail what that policy is.
Gillard in particular is caught between the anvil of Brown’s support for her slender grip on government and the hammer of community unhappiness about soaring power prices.
Rumours abound in the business community that she is in the throes of negotiating a deal with an initia substantial fixed carbon charge – Brown proposed $20 per tonne in the 2010 election campaign when Gillard was promising the nation her government would not introduce a carbon tax.
The quid pro quo, it is said, is that Brown won’t insist on a higher 2020 abatement target as part of government policy, although he will go on publicly campaigning for it.
Another version has Brown insisting on both the carbon price and an increase in the abatement target from five per cent below 2000 levels by 2020 to 10 per cent.
The current position now requires the elimination of 160 million tonnes of emissions annually by 2020 (see above). Federal Treasury modelling claims the previous 144 Mt target would require a $35 per tonne carbon price by the end of the decade.
Brown’s alleged 10 per cent target demand will push the abatement requirement to some 200 million tonnes annually, equal to all the emissions from electricity generation today, and will need a carbon price of more than $50.
The sharp political point for Gillard and the ALP is that a $20 carbon price will push end-user electricity bills up by about 15 per cent, without taking in to account the burden of network charges, the renewable energy target and solar subsidies, the drivers of today’s price rises.
A $30 charge will increase the impact on consumer bills to 25 per cent – and a $50 charge to about 40 per cent.
(The media claim that what is on the table is a $20 charge increasing by four per cent a year plus the CPI would deliver a carbon price of more than $35 by 2020.)
In these circumstances, the prospect – first articulated by the Business Council of Australia in October 2009 and rigidly ignored by Kevin Rudd and then Coalition leader Malcolm Turnbull in their personally fatal push towards an agreement on carbon pricing – of power prices doubling by 2015 is a racing certainty and the view of some in the electricity supply industry that they could treble by 2020 gains in credibility
With the political parties’ private polling already indicating that voters are “screaming” about power prices today, as one insider told me recently, this perspective is political poison for Gillard and the ALP.
How much more annoyed would ordinary Australians become if they actually understood the global arithmetic of emissions and their country’s relative position?
To get a handle on this, one must appreciate that Gaia is not engaged in counting molecules of carbon dioxide and delivering bad weather on the basis of who has been naughty and who has been nice.
Extreme weather, if it can, in fact, be attributed at present to man-made additions of carbon in the atmosphere, is the product of the impact of global emissions.
The US government’s Energy Information Agency, one of the major sources of energy data in the world, has recently published updated material on emissions from energy consumption, separating it from agricultural activity and deforestation.
It attributed about 425 million tonnes a year of the global emissions tally to Australia versus 6.4 billion for the US and Canada, six billion for China, 4.6 billion for Europe and 30.4 billion for the world.
And here’s the rub for Australians wanting to do the right thing: even if the Greens and activists here like Zero Carbon Australia had their way and we shifted entirely from fossil-fuelled power generation by 2030 – ZCA actually campaigns for this to happen by 2020 at a capital cost of $370 billion, nine times the proposed outlay on the controversial national broadband network – the world, according to the EIA, is on track for energy-related greenhouse gas emissions to rise to 39 billion tonnes by 2030.
In other words, Dr Garnaut, Australians can trek down your carbon road at very considerable national economic cost and the floods and cyclones you attribute to global warming will just keep coming.
(What an economist is doing pontificating on climate science and weather is a topic to be left for another day.)
Which raises the not unreasonable question as to whether we would be better off continuing to build the economy on relatively cheap electricity and developing a substantial fighting fund for adapting to a new world of more extreme weather over several decades?
The nuclear advocates say that this can be done efficiently while we are replacing many of the older coal-burning power stations.
Even if this view is anathema to Garnaut, Brown and others who share their opinions, how can they sustain the argument that Australians must – note the imperative – drive carbon abatement at home to “save the world” from the effects of global warming?
And then, of course, there is the small matter, as reported above, of driving coal exports ever upwards while driving coal burning down at home.
Keith Orchison
15 February 2011
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