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South Australia is leading the way on wind energy - but that's posing problems for the electricity sector. Wind image from www.shutterstock.com

Australia’s energy markets got a big shock in July this year, when wholesale electricity prices spiked in South Australia, alarming the state government and major industrial customers. Commentators rushed to find the immediate culprits. But the real issues lie elsewhere.

As shown by the Grattan Institute’s latest report the market worked. Having soared, prices fell back to more manageable levels. The lights stayed on.

Yet South Australia’s power shock exposed a looming problem in Australia’s electricity system – not high prices or the threat of blackouts, but an emerging conflict between Australia’s climate change policies and the demands of our energy market.

A perfect storm

On the evening of July 7, the wind wasn’t blowing, the sun wasn’t shining, and the electricity connector that supplies power from Victoria was down for maintenance. This meant gas set the wholesale price, and gas is expensive these days, especially during a cold winter. At 7.30pm wholesale spot prices soared close to A$9,000 per megawatt hour. For the whole month they averaged A$230 a megawatt hour. They were closer to A$65 in the rest of the country.

Australia has committed to a target to reduce greenhouse gas emissions by 26-28% below 2005 levels by 2030. Despite this well known and significant target, the national debate on climate change has been so toxic and so destructive that almost no policy remains to reduce emissions from the power sector in line with that target.

By 2014 the much maligned renewable energy target (RET), a Howard government industry policy to support renewable energy, remained as the only policy with any real impact on the sector’s emissions.

Wind power has been the winning technology from the RET, and South Australia has been the winning state. Wind now supplies 40% of electricity in South Australia due to highly favourable local conditions. Because wind has no fuel costs it suppressed wholesale prices in the state and forced the shutdown of all coal plants and the mothballing of some gas plants. But wind is intermittent – it generates power only when it is blowing, and the night of July 7 it barely was.

A report by the Australian Energy Market Operator noted that the market did deliver on reliability and security of supply in July. It reviewed the behaviour of market participants and concluded there were “no departures from normal market rules and procedures”.

The events of July do not expose an immediate crisis, but they have exposed the potential consequences of a disconnection between climate change policy and energy markets. If it is not addressed, the goals of reliable, affordable and sustainable energy may not be achieved.

The bigger problem

Climate change policy should work with and not outside the electricity market. With a fixed generation target of 33,000 gigawatt hours of renewable electricity by 2020 and a market for renewable energy credits outside the wholesale spot market under the RET, the conditions for problems were established some time ago.

The specific issues that arose from the design of the RET would have been far less problematic if one of the attempts over the last ten years to implement a national climate policy had been successful. A rising carbon price would have steadily changed the relative competitiveness of high and low emissions electricity sources and the RET would have quietly faded.

The first lesson for governments is that we need to establish a credible, scalable and predictable national climate change policy to have a chance of achieving emissions reduction targets without compromising power reliability or security of supply. A national emissions trading scheme would be best, but pragmatism and urgency mean we need to consider second best.

While such an outcome is the first priority, it will not provide all the answers. The rapid introduction of a very large proportion of new intermittent electricity supply creates problems that were not foreseen when traditional generation from coal and gas supplied the bulk of Australia’s power needs.

All of the wind farms in one state could be offline at the same time – a far less likely event with traditional generation. The problem can be solved by investment in storage and in flexible responses such as gas and other fast-start generators. Commercial deals with consumers paid to reduce demand could also contribute.

Lower average prices combined with infrequent big price spikes are not an obvious way to encourage long-term investors. The market may find solutions with new forms of contracts for flexibility or the market operator could introduce new structures or regulations to complement the existing wholesale spot market.

Much uncertainty exists, no easy fixes are in sight and the consequences of failure are high. Getting it right will provide clear signals for new investment or for withdrawal of coal plants as flagged by speculation over the future of the Hazelwood power station in Victoria.

Josh Frydenberg, as the new minister for the environment and energy, and his fellow ministers on the COAG Energy Council would be unwise to waste a near crisis.

Tony Wood owns shares in energy and resources companies via his superannuation fund

The Hazelwood power station has been named Australia's 'dirtiest' for its carbon emissions. Takver/Flickr, CC BY-SA

Over the weekend Fairfax media reported that the Hazelwood power station in the Latrobe valley could close as early as next April. Senior management at Engie, the French company which is the majority owner of the brown coal-fired power plant, has emphasised that no decision has been made yet.

As was the case with the Northern Power station in South Australia, the imperative to close Hazelwood has evidently come from the company’s board.

Earlier this year, Engie, the majority owner of Hazelwood, flagged it was considering closing or selling the plant. But at this point, no timeline for closure was suggested. Now it seems that Engie is planning to make a decision on the future of the plant at its board meeting in October.

There are many factors that would be contributing to their deliberation. These include, but are not limited to, the plant’s age, changes in the electricity market, and an erosion of the social license to operate, courtesy of long running campaigns from environment groups such as Environment Victoria.

Commissioned in the late 1960s, the power plant is almost 50 years old and one of the oldest coal-fired power plants still operating in the National Electricity Market (NEM). Smaller coal plants of similar age have closed in recent years, including Playford B in South Australia and Anglesea and the Morwell Energy Bricks Complex in Victoria.

Increasing amounts of renewable energy, and expected future increases would also be weighing on decisions to close. As has been well documented, there has been be an oversupply of electricity capacity in recent years. This has the effect of lowering wholesale prices and is exacerbated by increasing renewable energy generation.

What is interesting about both the potential closure of Hazelwood and the closure of Northern and Playford in South Australia, is that these have occurred in the absence of schemes like the (failed) “contracts for closure” and ANU professor Frank Jotzo’s proposal for brown coal exit.

On the one hand, this is good news for taxpayers and consumers. To date, the companies that own these assets are not being paid to close. On the other hand, the decision is made at the company level, without consideration for local workers and communities.

What would replace Hazelwood’s output?

Hazelwood has historically generated about 11-12 terrawatt-hours of energy each year. This is approximately 20% of all energy generated in Victoria, and 5% of energy generated in the National Electricity Market.

Like other brown coal power stations, Hazelwood produces cheap electricity (if we ignore carbon emissions). As a result, these power stations are used a lot (on average at more than 80% of their total capacity) and Victoria is a significant net exporter of energy.

Victoria exported 8.5 terrawatt-hours of electricity in 2014-2015 and 7 terrawatt-hours in 2015-2016, representing about 70% of Hazelwood’s output. A large share of this (approximately 5 terrawatt-hours) flowed to New South Wales.

If Hazelwood closes, the flows might substantially change. Generation in New South Wales could be expected to increase.

New South Wales is dominated by black coal generation, which is slightly more expensive that brown coal, and currently is used relatively infrequently. Over the past five years, NSW’s black coal power stations have operated at approximately 50% of their total capacity on average.

The idle black coal capacity in NSW alone could more that replace the energy output of Hazelwood.

But coal and other fossil fuel generation is only part of the story. By 2020, a large amount of renewable generation will have to be built to fulfil the obligations of the national Renewable Energy Target.

And the Victorian government’s Renewable Auction Scheme will see 5,400 megawatts of new renewable energy built in Victoria alone by 2025. This 5,400 megawatts will produce approximately 30% more energy than is currently delivered by Hazelwood.

What about emissions?

Hazelwood is also the most emissions-intensive coal generator still in operation in Australia. In fact it was previously identified by WWF as the most emissions-intensive generator in the major industrialised nations.

Based on current emission intensity estimates, Hazelwood produces around 15 million tonnes of CO₂ emissions per year, approximately 2.8% of Australia’s emissions.

However, this does not represent the overall emissions impact in the short term. In a high emissions scenario, the output of Hazelwood might be entirely replaced by NSW black coal (assuming the remaining brown coal power stations cannot dramatically increase their output). In this case, the total emissions from the electricity sector might reduce by only 5.5 million each year.

So, while we don’t know whether Hazelwood will close yet, we do know that Australia could easily replace the energy, and it could make a substantial difference to our carbon emissions.

The Melbourne Energy Institute, the Grattan Institute, the EU Centre on Shared Complex Challenges, GEE-21, the Australian-German Climate and Energy College, and ATSE are holding a symposium on Australia’s Electricity System: Transition to 2030 this week.

Dylan McConnell has received funding from the AEMC's Consumer Advocacy Panel and Energy Consumers Australia.

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