Pearls and Irritations

The Commonwealth should use its clear Constitutional capacity to seize sole control of the national energy market.

In the last six months Australia has had the first taste of just how tricky navigating the path to net zero, and meeting our 2030 goal, is going to be for the energy market in a time of geopolitical turbulence. This is particularly important because the electrification of everything will be a key strategy for reaching net zero.

We have three goals for the electricity sector:

• A stable grid with minimal power outages
• A reduction of greenhouse emissions consistent with our national target to cut emissions by 43% below 2005 levels in the next 8 years and reach net zero by 2050
• Affordable power for households and industry

Fifty years ago we lived with brown outs and blackouts. It was inconvenient but the economy and home life didn’t grind to a halt. Now communications, the internet, financial markets, ordinary business and commerce, public infrastructure like sewerage and water supply, health and education are all critically dependent on stable electricity supply. There is minimal tolerance for power outages. So a top priority for grid stability is a given.

Playing our part in the global commitment to tackle climate change is fundamental. We are already seeing the impact of climate change here and around the world. We have accumulating evidence that we are approaching tipping points in global systems – particularly in the oceans and the cryosphere. Stepping back from our Glasgow targets is not negotiable.

But achieving our climate goals will not be cheap

No government will survive long if electricity price increases get out of hand. it is a politically sensitive because governments are held accountable for price increases. And electricity prices will feed into inflation which is already a concern.

These goals – grid stability, net zero targets and affordability – aren’t simple to reconcile. We need to have a sense of priorities – if something has to give what will it be? Or do we step in to smooth the path through taxpayer funded subsidies?

It’s time to take stock of both what has happened here in the last six months and the chaos we have seen unfolding in EU and UK energy markets and think about the lessons we can learn.

Central to the challenge is that renewable power is cheap but variable. The electricity grid cannot tolerate variability. This means that there must be ways of firming electricity supply when we are in the cold doldrums. Firming can be done through a mixture of energy storage, and highly responsive generation – gas fired generators and particularly hydro power which is the most rapid to cycle generation up and down. Energy storage can be achieved by batteries (most cost effective for the short term – ie less than 12 hours), pumped hydro (cost effective for longer term storage but with long lead times for construction), chemical storage (eg the use of renewable power to create hydrogen which can then substitute for gas) or thermal storage (such as through heating sand or some other storage medium). Demand management can also be critical and geographically spreading renewable energy sources will reduce weather risk.

The Australian crisis – a rapid increase in prices and the threat of brownouts or blackouts – was precipitated by a lack of overall generating capacity coupled with scarcity of gas and a dramatic increase in its price in the Eastern spot market. This was exacerbated by a deep chill over much of the south east which saw power demand increase, and possibly by energy suppliers gaming the market.

The overall capacity constraint was caused by the reduction in coal fired power by 25-30% because of scheduled and unscheduled servicing, lack of availability of coal or flooding – this reflects the age of plants and lack of commercial incentive to maintain these assets plus climate impacts. The lack of incentive to maintain coal fired plants is because the marginal costs of renewable energy are so low that they drive coal power out of the market for significant periods of time significantly reducing their revenue. We had insufficient renewable power and storage to fill the gap – which pushed the burden onto gas fired peaking plants.

The scarcity and price of gas (and to a lesser extent coal) reflected global movements in price and availability following Russia’s invasion of Ukraine. Seventy per cent of east coast gas is exported so high global demand and prices are rapidly reflected in domestic prices and availability. In eastern Australia spot gas prices have reached 3 times last year’s prices since June.

Our problems are a pale shadow of those Europe and the UK are facing. There an absolute shortage of gas has arrived on the back of a temporary shutdown of about half of France’s nuclear power output turning France from a great electricity exporter to the rest of Europe to a net importer. The shutdown was to allow for essential maintenance deferred as a result of the COVID pandemic. One of the lessons from Europe’s pain is that surprises – COVID plus the Ukraine war – can happen and it’s important to stress test your energy system to make sure it is sufficiently resilient.

Perhaps what is most useful to us in the European experience is how to deal, or better how not to deal, with the impact of energy price surges on the community. There has been tremendous pressure to cap energy prices or to subsidise domestic energy consumption, or both. In one way or another most governments have surrendered to the pressure – is this wise?

The EU is struggling to agree a price cap on electricity and gas. The UK energy price guarantee aims to do the same. Controlling price will have impacts on both demand and supply of energy.

On one hand it will shelter consumers from the real price of energy suppressing demand management and leading to higher levels of consumption. The only answer to that is rationing.

On the other energy suppliers will face lower than globally available prices for supply to the EU and the UK. It is not clear how this will impact their willingness to sell to the EU and UK. The history of attempting to control price and quantity of supply simultaneously in the electricity and other markets is littered with disasters. Similarly tight price controls without rigorous regulation of anti-competitive behaviours by energy suppliers can cause shocks. The Californian electricity crisis of the early 2000s through to the collapse of Enron is but one example.

The Australian public tends to look at UK, European and North American policies and ask “if they are capping energy prices why don’t we?”. But we are in a quite different position. Across the UK and much of Northern Europe household energy costs are forecast to rise to 30% of disposable income if governments don’t act. By contrast for even our poorer households, energy costs mount to only 6-8% of expenditure – and perhaps a little more in our more extreme climates. This is a massive difference. We can and should be more selective than Europe and the UK in how we respond to higher prices.

Australia needs to focus on how to protect the most vulnerable if there is a further surge in domestic gas and electricity prices over the next few years. Best practice from an economist’s viewpoint is to make an income transfer to low and middle income earners but to leave price substantially uncontrolled beyond our existing regulatory requirements. The risk is that politicians will ignore this advice because they fear that consumers will trouser the income transfers and still blame them for the price increases.

But there are other important lessons from our domestic experience in the last six months which sharpen what we need to do – urgently.

The first lesson is that it was a tragedy to keep energy and climate policy separate as we have done for so long. The integrated nature of the energy market and its intimate relationship with climate policy means that you have to think about it from a whole of system perspective. All our political parties have an obligation to bury the impulse to pull them apart again. We really do need an economy wide carbon price.

The second is that a bigger electricity sector fundamentally dependent on renewable and possibly other zero emissions power like nuclear is going to require massive investment. That investment will have to come overwhelmingly from the private sector. This capital will only flow if investors are convinced that governments will act with enough sustained determination in applying their policies to reach the announced goals. Anything we can do to reduce the risk of policy flip-flops so that investors can concentrate on the technology and commercial risks they are equipped to manage is to the good. Investors need believable stability in government policy. Otherwise the outcome will be capacity shortfalls. That’s why legislating the 2030 and 2050 targets was so important.

But big picture targets are not enough in themselves. We also need to bed down the policy detail. The national electricity market’s emphasis on short term supply, without longer term supply guarantees, fails to ensure market reliability. Ours is one of very few electricity markets in the world which is an “energy only” market without some form of capacity mechanism. Capacity mechanisms provide a market based incentive for investment in an efficient mix of variable and firm capacity that meets reliability at the lowest cost. Similarly retailers should face a shrinking carbon cap in the bundle of electricity they provide to consumers. Breaching this cap should result in rising fines (effectively providing both an incentive to reduce emissions and a limit on costs consistent an economy wide carbon price). So my third proposal is that comprehensive market redesign needs to be done urgently.

Our fourth objective is obvious – working quickly to re-regulate the east coast gas market. The government’s wish to avoid risking Australia’s reputation as a reliable investment destination is understandable. But sometimes you should put Australia first – this is one of them. We need to make it easier to pull our domestic trigger to ensure supply sufficient to support a reasonable price. This might make achieving our greenhouse target harder, but grid stability is critical and this approach will provide breathing space while we work out our longer term resource rent tax options.

My fifth proposal is to up the tempo of investment in transmission and inter connectors. Our electricity market is, geographically, one of the biggest in the world with 40,000 kilometres of transmission lines and cables. It is also long and thin – it is leggy – unlike the much denser European, Japanese and North American markets. It is subject to extreme weather and bushfire risks and doesn’t enable us to take full advantage of our renewable power resources. Neither does it support reduction of the risk of renewable shortfalls by spreading wind and solar generation across different weather zones. To fix this we have to mobilise a huge level of investment – and spend it wisely. Are we confident that we are prioritising the right investments and making the right trade-offs between support for the grid and generation? Why is it that there are so few grid investments in our national infrastructure plan?

The sixth is that we need much more rapid progress in the use of smart metering in peak demand control and the incentivisation and coordination of Distributed Energy Resources (batteries and generators at the home, business and district scale). This has been delayed in the past by state based regulators.

Finally I wonder whether our national governance structure for the energy market is up to the task. It has become more centralised, but it still bears the hallmarks of a system cobbled together from the old state based, state owned and state regulated electricity systems. It builds on state greenhouse responses – themselves a reflection of the Coalition’s inability to lead on climate issues. It is replete with power sharing and multiple vetoes. It provides opportunities to make the perfect the enemy of the good – for example state governments vetoing any scheme that entrenches a transitional role for gas or more reliable legacy coal power. Multiple vetoes empower NIMBY movements which are inevitably more powerful at state than national level. It hampers rapid action and clear accountability.

So my seventh, and most radical proposal, is that the Commonwealth should use its clear Constitutional capacity to seize sole control of the national energy market. The Constitutional powers are clear – the Parliament’s powers to make laws for the peace, order, and good government of the Commonwealth with respect to trade and commerce (s51(i)), corporations (s51(xx)) and external affairs via our international greenhouse commitments (s51(xxix)) in a way that would invalidate any inconsistent law of a State (s109).

Easy?

Share and Enjoy !

SHARE TWEET SHARE COPY EMAIL PRINT