Victoria strikes deal with AGL to manage exit of Loy Yang coal power station

The Andrews government has struck a deal with AGL Energy to manage the retirement of the Loy Yang coal power station.

Victoria will pay to keep AGL Energy’s Loy Yang A coal power station open until 2035, striking a secret safety-net plan to avoid blackouts before replacement green power is built.

The Andrews government has agreed to underwrite the state’s biggest electricity generator, removing a risk that could have seen the energy plant shut down years earlier if low wholesale electricity prices eroded its profits.

Victorian Climate Action, Energy and Resources Minister Lily D'Ambrosio refused to be drawn on the details of the risk- sharing mechanism agreed with AGL, the second secret deal struck to prop up coal after a similar pact with EnergyAustralia’s Yallourn station two years ago.

Victoria has legislated Australia’s most aggressive energy transition policy that has seen the state commit to cutting emissions by between 75 and 80 per cent by 2035, while bringing forward its net-zero target by five years to 2045.

To achieve this, Victoria will prohibit coal power generation in the state by 2035.

“This will ensure that Loy Yang will continue to provide power to Victoria until 2035, keeping the lights on while we build renewables and storage ­capacity to reach our government’s target of 95 per cent ­renewable electricity generation by 2035,” Ms D’Ambrosio said at a press conference at the power station in Gippsland, in Victoria’s east.

“The structured transition agreement does not provide payments to keep the power station open, nor does it provide payments to close it early. Rather, it provides a framework of certainty that is agreed between the Victorian government and AGL: certainty for workforce, certainty for community, certainty for the ­renewable energy investors, knowing that they can build with confidence,” she said.

While Victoria has taken a hard line, there is widespread scepticism about the capacity of the state to deal with loss of coal generation, especially if one of the dominant electricity generators were to retire earlier than scheduled.

Victoria in 2022 opposed ­efforts by the former federal ­Coalition government to develop a capacity mechanism, which would have paid generators – ­irrespective of the energy source – to ensure sufficient capacity. Victoria and other opponents dubbed the policy “coal-keeper”.

AGL last year said it would shutter its Loy Yang coal power station in 2035, a decade earlier than previously planned, after sustained pressure from investors — including the company’s largest shareholder, billionaire Mike Cannon-Brookes.

Australian energy market authorities believe Loy Yang is vital for Australia’s energy security until 2035, but coal power ­stations are under mounting economic pressure.

Typical coal power stations are inflexible and generate electricity throughout the day with little variance in output. But the rise of solar and wind generation has sent the wholesale price of electricity to zero or even in negative territory, meaning many coal generators are often making losses during daylight hours.

Losses are pared later in the day when the sun sets, but a rise of batteries threatens to exacerbate the financial losses of coal generators.

AGL chief executive Damien Nicks earlier this month said the company had invested significant sums to ensure its coal fleet had flexibility and was therefore less susceptible to the economic pressures. Still, the rise of renewables threatens the economics of even the most flexible of fossil fuel generators.

In a deal that ensures AGL does not close Loy Yang prematurely when the broader National Electricity Market requires the generation capacity, Victoria has agreed to share any future financial pain with the retailer until 2035 – effectively safeguarding the future of a generator that produces about 30 per cent of the state’s electricity.

AGL chief operating officer Markus Brokhof refused to ­disclose the financial terms of the arrangement. “The risk-sharing mechanism is of a commercial ­nature, and we are not disclosing any details,” he said.

RBC Capital Markets analyst Gordon Ramsay said the guaranteed revenues would aid the ­retailer’s capacity to invest in ­renewables. “We view this agreement positively as we believe it provides ­additional certainty for future cash flows for the Loy Yang A power station,” he said.

AGL said last year it would spend $20bn to develop a pipeline of renewables to replace coal, which it will exit with the mothballing of Loy Yang.

While some investors will cheer the earnings insurance of the deal with the Victorian government, it remains to be seen the reaction of Mr Cannon-Brookes, who has vowed to continue pressuring the retailer that he this month dubbed “one of the most toxic companies on the planet”.

If Australia has developed enough renewable energy generation capacity before 2035 and Loy Yang is enduring financial losses, AGL and Victoria could jointly agree for the early exit of the generator, but it will require endorsement from the energy market operator that there is ­sufficient capacity to compensate, The Australian understands.

However, Australia is struggling to build enough renewable energy sources to replace the fossil fuel capacity leaving the system already, so an early exit ­remains unlikely.

Such is the pace of building renewables, there is also heightened alarm at the capacity to ­adequately replace Loy Yang in 2035. If Australia does not build enough renewables to replace coal, power prices will increase.

Victoria has used these so-called closure contracts before, striking a deal with EnergyAustralia to manage the closure of its Yallourn coal power station in 2028. The terms remain secret.

The AGL deal with the state government was unveiled just days after Alcoa – one of Victoria’s biggest manufacturing employers with close links to the Labor government – said it had entered into a nine-year supply deal with the retailer to safeguard the future of its Portland smelter, which produces around 20 per cent of the nation’s aluminium.