A gradual degeneration of Stockdale’s vision

Blackouts in SA, BHP’s Olympic Dam power costs rising $30m in one year, businesses worried their power costs may rise.

View of the Hazelwood coal fired power station, Melbourne.

Blackouts in South Australia, BHP’s Olympic Dam power costs rising $30 million in one year, businesses worried their power costs may rise by $7 billion this year. How did we get into this mess?

Former Victorian treasurer Alan Stockdale’s vision was to create a competitive power market that would deliver the least cost solution and monopoly poles and wires would earn a fair, regulated return. The market design initiated in Victoria worked well for 15 years but several factors have conspired to hamper its effectiveness.

The market has not coped well with the renewable energy target and other renewable energy support programs.

Designed with the expectation that load would keep growing, these policies helped deliver 8000MW of surplus power and prices were suppressed. The market responded as you would expect, first with gas and then the older coal plant withdrawing.

The system is more finely balanced now but the intermittency of renewables has led to volatility and technical issues. Although costs have reduced materially, renewable subsidies are estimated by the Minerals Council at $3bn a year, not including grid subsides.

Ongoing uncertainty about whether a price on carbon will be reintroduced at some point is also hanging over investors but renewables are proceeding apace. The promised target is in sight.

Meanwhile, a shortfall in expected delivery from fields supporting the LNG projects and collapse in the oil price led to significant demands on gas resources previously serving the domestic market. Concerns in rural communities about the long-term effects of coal-seam gas on water tables and the like resulted in moratoriums on new production in NSW, Victoria, the Northern Territory and Tasmania. Now the Australian Energy Market Operators (AEMO) tells us it expects a gas supply shortfall from 2018/19 and prices have risen from $3 a gigajoule to $9 to $12 making gas-fired generation a difficult proposition.

Not helping is NSW privatising its power assets 20 years late and Queensland still ruling it out. The Productivity Commission has found that network costs are far higher as a result. Victoria’s expensive smart meter rollout was another factor.

We have moved from among the lowest cost energy countries to among the highest. Some say everyone will be at these levels if they meet their Paris commitments and we are just a bit ahead of the curve. But while prices would inevitably rise as coal plant retires, we have not managed it well.

The Turnbull government has tried to address the gas problems by calling in the Gladstone participants with a stern warning that they are expected to use their own gas resources. The outcome is uncertain but the state and territory governments are still refusing to budge on their moratoria. AGL is even considering LNG imports.

Rather than review the renewable energy target again, governments are turning to more subsidies and interventions — Victoria’s costly 5400MW renewable energy target, temporary diesel generators, and more grid scale batteries (these have been trialled already) are likely changes to clear the way for a new NSW-South Australia interconnector (paid for by NSW and SA customers), the SA government’s own new gas-fired plant and tender for supply from another, ACT’s tender process, a dramatic new plan to expand Snowy Hydro, calls for the market to start paying for backup power and plant to tackle the renewables’ technical issues and Alcoa’s bailout (watch this space, there will be more to come).

Some of these measures are like trying to put out a fire with kerosene. Virtually no investment is occurring that is not subsidised or part of an intervention.

You would have to invest without knowing where these will finish up. Price volatility which may have rewarded new investment will be blunted. The world is watching — similar problems are emerging in Europe where thermal plant is incentivised to maintain reliability.

There are also calls for an emissions trading/intensity or some other scheme to commence in several years’ to provide long-term certainty to support investment, even if it means even higher prices (although some argue it may not). The ERF safeguard mechanism isn’t seen as a long-term solution.

Calls are even coming for the market to be trashed and replaced with a regulated price. My view is that Stockdale was right — efficient markets will deliver the lowest cost but you have to let them work. Interventions must be kept to a minimum.

If the new world must feature ongoing government interventions they must be tightly prescribed in a long-term framework so investors can take them into account. Otherwise Paul Kelly’s observation that “Australia has become derailed on to the path of state intervention and seems unable to escape” will become entrenched.

Robert Nicholson is a partner with Herbert Smith Freehills