Hang on to your hat as energy crisis likely to get worse

The Moranbah Gas Project coal-seam gas processing plant in Queensland’s Bowen Basin. Picture: Simon Green

Did anyone else notice the remarkable disconnect between last week’s budget speech delivered by Jim Chalmers and the actual content of the budget? In the speech, the Treasurer declared that Labor was delivering on its commitment to “cheaper and cleaner energy”. But in budget paper No. 1 we were informed that electricity prices would increase by 56 per cent across the next two years.

There is no doubt Labor is vulnerable on energy policy in general and on electricity prices in particular. Having repeatedly promised that household electricity prices would be $275 a year lower by 2025, the government ultimately will have no option but to walk away from this pledge.

Of course, it was a pledge that never should have been made, notwithstanding Anthony Albanese’s further claim that he “stands by the modelling”. (No one in their right mind would stand by assumption-laden modelling.) He is now keen to blame Russia’s invasion of Ukraine as the reason for rising electricity prices. Here’s the thing: the energy crisis in Europe predated Ukraine. And does anyone expect that energy markets will return to pre-existing conditions should the Ukraine situation be resolved soon? Most Western economies will continue to boycott Russian oil and coal, and the piped gas from Russia to Europe is unlikely to return to previous levels.

Many of the problems in Australia’s energy system are homegrown; it was only a matter of time before the full effects became apparent. As far as electricity on the east coast is concerned, the key problem is that the scale and timing of the exodus of 24/7 power plants – mainly coal-fired ones – have been such that even the substantial investment in renewable energy has been inadequate to deal with the shortfall, particularly given its intermittency.

Add the increasing unreliability of many of the remaining coal-fired plants – there is little incentive for owners to invest in adequate maintenance – and the stage is set for rising prices and loss of reliable supply.

The fact the Australian Energy Market Operator is constantly intervening in the market – it was suspended at one stage in the year – underscores the increasing fragility of the grid.

The trouble with spouting cliches such as renewable energy is cheaper energy is that it ignores the underlying physics, engineering and economics that drive electricity grids serving households and businesses.

Gas is increasingly becoming the key factor behind electricity prices because it is gas that can provide the firming capacity that allows the grid to operate 24/7 throughout the year.

As the marginal supplier, it is gas that determines the price, particularly at peak periods. For all the talk, batteries, even large-scale ones, don’t come close to providing equivalent firming capacity, even though they may offer up some ancillary services such as frequency/voltage control. This is why the distortions in the gas market are critical to understanding what is happening in the electricity market.

Treasury is expecting gas prices to rise by 40 per cent in the next two years. There is only one way in which the price of gas can sustainably revert to lower levels and that’s through more supply. All the talk of price caps, regulation, reservation schemes and higher taxes ignores the fact these interventions will all fail in the medium term and most will fail in the short term.

Beneath what is happening in the gas market is the belief by the producers and investors that the Labor government is hostile to gas. Climate Change and Energy Minister Chris Bowen has no intention of facilitating new sources of supply, including by underwriting the construction of pipelines. He has put the kibosh on the construction of the new government-owned Kurri Kurri gas-fired plant in NSW by insisting it run on 50 per cent hydrogen from the get-go, notwithstanding the absence of any source of hydrogen in the area. He also has vetoed the expansion of another gas-fired plant owned by Snowy Hydro.

We know there are very large gas reserves in Queensland’s Bowen Basin that could be accessed with the consent of the Queensland government. Likewise there are reserves of conventional gas sitting onshore in eastern Victoria, but there is no political appetite to facilitate their exploitation notwithstanding the high gas intensity of Victorian homes. (It is ironic that, in days gone by, Victorian households were encouraged to install gas appliances and hot water services and large swaths of the state are reticulated for domestic gas use.)

So the short answer is that, absent a policy to increase supply, we should get used to high domestic gas prices for the foreseeable future in line with high global prices. On paper, it may seem possible to restrict exports, but bear in mind the gas fields in Queensland, in particular, were developed only because of those export contracts.

Insisting that contracts be broken with international customers would be a very big call, with potentially damaging consequences down the track. Slapping an excess profits tax on the producers would generate revenue but bear in mind that the massive costs of the investment in the Curtis Island LNG trains and associated expenditures have not even been recovered at this point.

High gas prices also are affecting those manufacturers that use gas directly as a heat source in their production processes. While there is some speculation about altering processes to reduce the reliance on gas, at this point these manufacturers will be badly hit. Quite a number of them failed to secure longer-term gas contracts on favourable terms when they were available.

The bottom line for the federal government is that simply saying renewable energy is cheaper does not make it so. Not only are there substantial delays and cost blowouts in the new transmission lines required to get the renewable energy to the grid, there are also significant rises in the price of turbines and solar panels. China, the dominant supplier, has seen an opportunity in the market and has pounced.

As for Daniel Andrews proposing to resurrect the State Electricity Com­mis­sion of Victoria, this is simply politics but bad policy. A mere $1bn is to be devoted to the new entity by the state government across 10 years and the other 49 per cent will be offered to private interests to reduce electricity prices for Victorian consumers. It may help the Victorian Premier win the state election and it is enough to distort the market further even given its small scale. But any near-term impact on electricity prices is fanciful.

My advice is to hang on to your hat because the energy situation is likely to get worse. Only when common sense prevails will things improve.