Origin Energy CEO Frank Calabria’s speech to the CEDA Energy Series lunch, Sydney, 25 October 2019
Thanks very much, Chris [Flynn, Gilbert and Tobin]. Good afternoon everyone. It’s great to be here I’d like to thank Lee [Kelly] and CEDA, first of all, Chris for the kind introduction.
Both Lee and and Chris made acknowledgement of the Gadigal people. I just want to probably extend that acknowledgement. We’re acknowledging that they are the traditional owners of the land on where we meet, but also think we should acknowledge that Aboriginal and Torres Strait Islander cultures are the oldest surviving continuous cultures in the world. That’s worth reflection and it’s worth the reflection that their strong and enduring connection to the land and water is pivotal. When I think about where we are as a national identity, I believe it’s very important to keep the spotlight on recognition and reconciliation, if we are to continue to progress in this area.
I’m here to talk about getting back on track with energy. And I say back on track because there is plenty going on in the sector. But when I reflect over the last few years in energy, I think about the double-digit price increases that customers experienced following the rapid closure of both the Hazelwood and the Northern power stations. I think about the two energy policy frameworks that that came and went, firstly under Finkel called the Clean Energy Target and then under the work with the federal government and across the sector, we went very close with the National Energy Guarantee.
It’s every day, including today, that you see energy in the papers. You see fierce agreement, generally by most people about the objectives we want to achieve. It’s therefore quite puzzling that when you sit around, why is it that everyone is stuck and why are people arguing, and why we’re not moving forward?
Energy policy has been the undoing of political leaders for the last decade in this country. We are now in a situation where there’s a plethora of specific fixes in place in lieu of an overarching long-term plan addressinh affordability, reliability, or reduce emissions or more broadly a sustainable future. So today we have things like price re-regulation, we have Snowy 2.0, we have the underwriting of generation investment and we have state climate targets in lieu of the federal one beyond 2030.
Now a lot of people are coming from a good direction, and there’s certainly no shortage of effort, but that intention is not really translating to what we need if we look forward to 2030 and beyond, 2050. Despite all the activity, there is no long-term plan. It’s more urgent than ever that we address that, because we have the next tranche of plants due to exit the National Electricity Market in 2023. And I believe that all energy users are paying the price for that disorderly exit today. It’s incumbent on us, that we actually plan for a future so it delivers better outcomes for customers.
I want to talk today about the path to 2050. It aligns with the purpose that we have at Origin, which is getting energy right for our customers, getting energy right for the community, and also getting energy right for the planet.
It’s worth just reflecting the role energy plays first, because I think that’s what we need to ground ourselves. Energy is fundamentally important to the economy that powers every industry, it powers, millions of jobs. It’s a major factor in our competitiveness in the economy, and certainly plays a role in everyone’s lives at their homes each day.
But we also need to acknowledge that this industry is changing, incredibly rapidly. Coal to renewables, the growth in distributed energy resources, I’ll touch on a number of those changes because they do inform the challenges that we’re presented with, and the particular ones that I believe need to be addressed with urgency if that plan is to be successful over the longer term.
If we don’t get on top of this change, it will cost more, it will impact reliability. And that’s something we have already seen over the last several years. And as we face into another summer where there’s a tightness of a supply and demand, it’s ever present in the minds and hearts of many people across Australia. We need a framework that ensures we secure the right investment at the right time.
Let’s think about the transformation underway. I don’t need to tell you that there’s a massive transformation underway, but I want to highlight the dimensions of that transformation.
The first aspect is the coal to renewables transformation. Since 2014, 4000 megawatts of coal have left the National Electricity Market and renewable energy today represents 21 per cent of the capacity in the market up from 4 per cent – that’s the last four to five years.
Rooftop solar is the second one – 2.2 million households now have rooftop solar and it grows daily.
Those two dimensions of the transformation already have an energy market that is moving down to prices in the middle of the day, to the base price or the lowest possible price in the National Electricity Market, which is minus $1000 a megawatt hour, and by the evening peak it’s climbing back up to $300 a megawatt hour. Then when you go to the peak demand and supply, which could be driven by both supply shocks or very high demand periods, we’re seeing those prices go up to the theoretical maximum of $14,700 a megawatt hour. This profoundly changes the way the industry needs to navigate a future.
The third dimension of that transformation underway is that customers are now generating and selling back to the grid. Battery growth is occurring. It will take place as costs continue to reduce. It’s actually prohibitive for many customers in the market today, but make no doubt about it – battery costs will continue to reduce and will play a role as we go forward. Research that Origin’s undertaken is that six out of 10 customers would be interested in purchasing a battery and 60 per cent of those are driven by cost reasons, not driven by really an emissions reduction future.
The fourth aspect of that energy transformation underway is electrification. Probably the key beacon for that electrification is in fact the rise of electric vehicles. Like solar and storage, [EVs] will go through a cost curve reduction and a performance improvement. You are already seeing the signs of this globally with the new models that are coming out every single year that are now performing up to 500 kilometres under [a single charge]. What we will continue to see is the reduction in cost over time and which will see them move from niche to mainstream.
The fifth dimension of the transformation is the one that Chris [Flynn] really spent some time talking about and that is customers and technology and really the impact of the digital age coming to the energy sector. It will impact both customer experience, but more importantly, it will actually transform business models.
I’ll give you an example of a recent trial where through artificial intelligence, we deployed devices to a number of customers where we were able to control their air conditioning remotely. What we asked them to do was to participate in demand response which enabled us to increase the temperature on their air conditioners by several degrees and hot days to manage that demand. As we become a more interconnected world and electrons move around the grid in multi-directional ways, people will interact with energy completely differently, enabled by capability in the management of large amounts of data and the ability to attach that to the underlying electrons in order to move that in the most efficient form within a house, within a community, within a grid and across the entire National Electricity Market. The investment by the industry that continues into that space is significant.
The new normal that will emerge has a profound impact on how the industry operates. The traditional model today of a retail sector (I know we have got many other participants on the value chain here) its key capabilities is in fact, its ability to manage the risk of supply and demand on a moment-by-moment basis. It provides it at a cost much lower than what you could do all individually to manage that risk. We manage load and supply across a range of generation technologies and different demand profiles, and we convert that using billing capability so that what customers receive is one bill at the end.
But think about a future where millions of customers are generating, they’re storing, they’re dispatching, they’re doing that alongside generation plant, and we will need to be able to play a role that continues to evolve to offer products to those customers, but also combine what we’re good at today with the ability to manage millions of devices and orchestrate that across the energy chain.
There’s a couple of key things that emerge out of this transformation. There are many of these things that are going to occur under any scenario, there will be the growth in renewable energy over time. There will be a growth in distributed energy resources over time. There will be a lower emission future. But what we are now navigating is how to transition towards that future where Australia particularly has the challenge of still having some 60 to 70 per cent of the energy produced by coal, and that coal is actually ageing and needs to be replaced by a suite of generation.
At the heart of this challenge, is the fact that the renewable energy that we’re building is certainly lowest cost, but cannot support the entire load every day, 24 hours, seven days a week. It is what I will loosely describe as firming generation, that has a lot of complexity to it, and really sets the key challenge for the sector today, and it’s where most of the investment needs to flow.
Now, based on that future that I’ve described, they will be both distributed and centralised energy. There are various scenarios about how far [rooftop solar and batteries] will penetrate in the market, but we do not see a world that that ever replaces the need to be centrally generating energy and providing it as a firm supply to our customers. If you hold that belief, we must face into this challenge of how we actually are going to invest in the right forms of technology into the future.
It’s worth reflecting on the National Electricity Market. The National Electricity Market has been around for 21 years. It set the rules, it sets many rules by which all of the participants have operated a long time, and really one of those key rules is that it actually also set the signal for when we would invest in new capacity in the market. For many years, that worked well but we’re all asking questions now about whether that’s fit for purpose. What it’s done is as a National Electricity Market is it provides that reliability and interconnectivity, and what it has essentially done for many years is provided an effective signal so that as wholesale prices went up, it’s a signal that new generation was required, the generation was invested in, and as a result you would see a wholesale price reduction over time.
But it is hard to argue that it is working well today when you think about the price escalation over the last several years, and you facing into a reliability concern for this summer, and as we have, last summer.
Now sitting at the backdrop of this is a decade, as I will describe broadly as, of policy inertia. There is only been one really enduring mechanism that’s been injected into the market over the last 10 years and that’s the Renewable Energy Target.
So play forward over the last 10 years what has happened – we have had a huge amount of renewable investment. The market has responded to that signal. But what has missed in that last period of time is there has not been the equivalent signal to invest in what you need to firm it up. What we have, therefore, is renewable energy investment last year alone that doubled from 2017 to 2018 to $20 billion dollars. 14 and a half gigawatts under construction, coming in at a rate that no one anticipated several years ago.
If you then think about what needs to operate alongside it, since Mortlake was invested at the early part of this decade, there has not been one further form of what we call firming generation that’s constructed.
Underway right now is Barker Inlet by AGL in South Australia, and I know the comments earlier this week by EnergyAustralia, their attempts to actually build Tallawarra, and they’re actually currently as I read, having planning difficulties associated with it.
What that sits at the heart of that is the National Electricity Market therefore needs to incentivise it. Currently the rules that are associated with this, we need to break down the forms of generation that are going to be required and I think this helps us probably frame up that this is not just one-size-fits-all.
We’ve got our good friends from AEMO here – every single day as market operator, [they] are facing major challenges to manage the technical system requirements of the energy market. And that’s for security purposes. Because if that frequency actually falls out of range, or there’s a voltage variation- forget the market price, we don’t have an energy system that works.
What people need to recognise is that for decades, that was a free service that came along with your coal and gas-fired generation. It is not a service that is easily replicated with renewable energy. That’s something that they need to actually have to support and therefore they need instantaneous response. At the moment, what they’re doing is managing standards and directions and mandating in order for it to occur. I’m sure they would agree that over time it would be much better if there was a firm signal going forward for inertia and frequency that enabled that to be something they could rely upon in the market.
Secondly, you might hear quite often that people talk about, we have this theoretical cap price of $14,700. What does that mean? Now many people operate in the sector and I could get Chris Flynn up here to talk to you about it. But the reality is, what did that price come from? That price came from the fact that there was a design of the National Electricity Market that wanted to meet reliability at 99.998 per cent. Surprise, surprise, when you do the mathematics around achieving that reliability standard and go to the former market convention of building gas-fired generation, it equates to that signal as a price theoretically to drive that demand, for that reliability to be met.
Now, if you have a look at it, its objective is to meet that reliability and it’s also there to protect market participants against sustained high prices. At the moment, you’d have to say it’s not meeting that objective or rapidly moving towards not leading that objective, and therefore causing the question as to whether changes about that cap or other signals for reliability are required.
Those are two key things, we call one security – the system needs to run – secondly, it needs to be reliability. What we need, really most critically right now when we talk about investment needing to flow, is an incentive to what I broadly described as firming generation. There’s just one sort of caveat to that because one of the things that can occur is the demand response can be a very effective form of meeting some of that requirement, dispatchable energy that can be produced on demand – it’s not dependent on weather, it’s not dependent on patterns, it just can be dispatched whenever you expect it to be.
As I said earlier, there’s not one generation type that solves every problem. There are three areas that will need to be solved by market design as we go forward. One is what we call the very fast start, the instantaneous response to the frequency and inertia of the power system. That’s why batteries are featured so commonly. They are instantaneous, coming in very short bursts and they tend to not be available for a long period of time, but perform a critical role for that short burst. That’s one role and we need an incentive for it in the market design.
The second is that every single day, there’s solar coming in the middle of the day, and in the evening the sun goes down. So the challenge now, what we described as covering daily peaks and shifting energy between the middle of the day and the evening, is going to require a very flexible fast-start form of generation and demand response on a daily basis. That’s why you’re seeing the next fastest forms of generation that can run for hours on end, being both pump hydro, and also therefore very fast-start gas-fired generation.
The third incentive that is required is in fact what happens on a hot day, what happens on many days of low wind, what happens on many days of cloud cover – you need plant that can run for days or weeks, or where there’s a supply of the heat over summer. That’s where you’re looking at larger storage hydro, or more conventional open-cycle peaking plants that take a little longer to start up that can run more efficiently over time. I won’t touch further on gas, but you can now understand why fast-start gas, and even open-cycle peakers is why now gas has become a pivotal part of the story. They will need different incentives and there will be different types of firming as you can see right now.
Now there’s one other aspect that I think it’s also worth noting before we go to that future state and how we might think about the energy sector and that is transmission. The rise of renewables is going to occur. And there is no doubt in our mind that additional transmission will be required for that renewable investment to be made. But there is one really big difference between transmission – it is not perfectly replaceable for generation. The second thing is that transmission transfers the risk from private investors [and] shareholders to all of you as consumers, because it is part of everyone’s bill as part of a regulatory determination. So all I ask is that we should be very careful about the amount we invest in that and [being] very confident it’s the right set of investments, because if we over-invest, it’s very expensive for everyone.
I’d leave you with the message that the National Electricity Market is not broken beyond repair, but the urgency right now is that the policymakers, politicians and industry agree on those incentives to get the investment to flow and that are required as we think about ageing coal coming out of the system through its natural order over a period of time, and into a future energy market design.
Now let’s think about the uncertainty that presents to that investment today in the absence of those signals. The big stick has got bipartisan support and is likely to go through the Senate. So it’s going to be there. We’ve heard from government they don’t expect to use it, it’s still there nevertheless. We will work with governments whatever they introduce, but I just leave the message that I don’t believe it actually improves affordability of energy, and I certainly don’t believe that it adds to the capacity being built in a more timely fashion. If you’re thinking about a smooth transition, I’m not sure it serves the purpose, to a lower mission world where you’ve got high reliability and higher affordability.
We continue to work productively with all of the changes coming to the energy market. We also at Origin take a very long-term view on our portfolio, so we’re getting on with it and managing the big transition. But I just like to leave the message that in the absence of a holistic approach to energy reform that does coordinate industry participants, the outcome will be a suboptimal one for customers. And that’s what I don’t think we should ever lose sight of.
People say well why do you think uncertainly clouds investment? I just like to leave you with just a few key messages. Everyone invests in uncertainty. But just reflect on the fact that this sector is contending with a big stick legislation just introduced. We have Snowy 2.0, it’s got to go through its environmental impact statement, it’s going to go through a transmission assessment. We have an underwriting of generation investment, where there’s a shortlisting of candidates, we don’t know what they are yet. We have a Liddell taskforce talking about how long is Liddell in.
The government’s entirely focused on trying to come up with pragmatic solutions in the short-term. But think about the parameters upon which a board would be making a decision as to whether to invest in a market when that’s going on. I do really think that the overarching message from that is that the private sector just needs to understand the extent and scope of the participation of governments now in our market, and that itself represents a sort of an overarching uncertain framework in which we’re asking boards and management teams to invest in assets that are likely to be economic for the next 20 to 30 years.
It’s a very difficult assessment and all I’d say to you is that if you think that’s self-interest, I would go to the facts – there’s nothing [that has] really been built in the last 10 years. It’s not just [Origin], it’s a sector speaking out loudly.
The other thing too is if you go forward, you got federal emissions that’s finished in 2030, in fact the investment to achieve that federal emissions is largely done, and in lieu of that what we’ve got is that states have announced renewables and emissions targets. We argue, really the national approach is better, but what you’ve got now is a variety of mechanisms that people will be managing the complexity of.
Now when I speak of targets I’ve got a minister that actually says that he wants a $70 wholesale price in the next couple of years as well so that’s another informal target that’s been set as well.
If you think about that backdrop and that background, what really is the challenge presented to currently the Energy Security Board, the Australian Energy Market Commission and also AEMO is that they’re grappling with the higher order questions about market design right now. Now I would say that individually, these are measures that have been introduced by governments I think they come from the right place in many, many cases. But the sheer volume of activity increases the likelihood that these measures and incentives will increasingly be at cross purposes. We need to we need to take a calm breath because that’s actually just compounding every single day.
Where to from here to deliver an energy system that serves the needs of customers? The first thing is we need to operate in the context of greater variability and uncertainty in both supply and demand.
Directionally we know a few things. We certainly know that over time, the amount of coal generation will reduce. We certainly know, directionally, the amount of renewables will increase. And we certainly know directionally that the amount of distributed energy resources whether it’s rooftop solar and batteries will increase as well. It’s impossible to know when you look out to 2050 the right mix and the emergence of new technologies and their impact.
The one thing I’m really clear about is that 2050 will be lower emissions. We’ve long held the view that we have to be at net zero emissions for the electricity sector by 2050. Think about its impact that it could have more broadly in the transportation sector, we certainly feel [the electricity sector has] got to do more than its fair share of achieving that.
The big variables for us are really now how much does distributed energy resources, how much demand will be driven by electrification through electric vehicles, the impact of batteries and other things that are occurring [impact] the supply-demand equation. It’s only last week that there’s questions around the smelter plan associated with Portland. For people that are interested, you all be well aware of just how much demand smelters consume of electricity in this market.
Now the only the other thing I would say is something we do know is that we know that our customers in 2050 are going to want a firm and reliable supply of energy. We will need to be able to deliver that to them. And I believe that they will want that to be lower emissions at that time.
This brings me back to that point about what is that incentive that brings on the right forms of generation. Now the Energy Security Board right now, their review seems to be boiling down to whether or not we need to introduce a capacity mechanism, or elements of a capacity mechanism.
I think it’s worth recognising that there are various different types of capacity mechanism. The first is the reliability obligation that’s been brought in by the government is one on the 1st of July is in fact a form of a capacity mechanism that’s integrated as a retailer obligation. But that could go all the way through to what we’ve recently seen introduced into the UK. You’ve heard policy makers and you’ll hear it from me today that we are very cautious about whether that fuller capacity mechanism like the UK will deliver the right outcomes. There’s a reason for that – it did not distinguish between any forms of technology so what occurred in that case was the first round meant that more coal was supported and therefore it cut against their emissions reduction. The second round then supported more modular generation [in the form of] diesel. If they are the outcomes and we still want to actually have lower emissions, you’ll see that they run in direct conflict.
The overarching message for most people on capacity markets is that people are very cautious about the fact that it will add a lot more cost into the system by virtue of having that firmness, it’s just one of the design features that are there. So one of the key things around a capacity mechanism, we would say that the full suite of those mechanisms all the way from that reliability obligation through to the former ones need to be assessed.
The key thing is it must be very clearly understood that it has to be on some sort of targeted volume-based measure, which allows for the procurement of the right type of generation. We’re talking about a variability of supply and demand instantaneously by hours and by days and weeks, and it’s not anything to do with an ideological message on coal. We all know operating in the sector that coal actually struggles to achieve that. So when I say it’s not the right type of generation, it’s actually founded in this variability of supply and demand that it was not built to achieve. And that’s what’s going to increasingly be a challenge for the sector going forward. So picking winners is not the answer and extending the life of our coal plants, without a strong carbon signal will just extend uncertainty that we’re all facing today. And it also will deny the inevitability of a lower emissions future which we will need to deliver for our customers and the community as we go forward.
The key message for me is that the capacity mechanisms that we contemplate, which could be, as I say, very much flowing from the design of the current market, need to go hand in hand with a strong carbon signal if were to achieve our overall objectives of a lower emission future. Why do I say that? Because I believe it needs to minimise distortion in the market, and it needs to minimise deferring further investments and also minimise the increased cost to customers.
Now the industry has worked hard to reduce emissions. You’ve seen the growth of renewables, you’ve seen the growth in distributed energy resources like rooftop solar, and they’re growing rapidly. But that’s now challenged our reliability. It’s pushing coal harder and harder to run more flexibly every day. And it has also come at the expense of affordability when coal leaves quickly. We need these firm forms of generation to come in and it’s in the best interest of all energy users that we set that strong signal.
That signal, I would describe as three things. It’s the carbon signal. It’s not a carbon tax, but it really is restricted to the generation sector to make sure that over time there’s an emissions reduction pathway. Secondly, there needs to be a signal for that inertia and frequency to support the security of the system. Thirdly we need a reliability signal set by the market and whether that’s an adjustment to the market cap of $14,700 that’s not high enough to drive investment, combined with a review of the reliability obligation as we see whether going forward if it’s strong enough. We need to be ready to make those strong signals if necessary, because right now the price for firming energy just is not enough to ensure that what we need is actually built.
How do we get back on track? I believe that the heart of this is, and it may be something that’s difficult to achieve, is a platform of consensus – really across the industry and the policy and politicians, to give the community confidence that steps have been taken to manage the transition. Because if we keep the customers in mind, reliability and affordability are the key priorities that everyone is focused on right now.
There will be an orderly exit of coal. It will be replaced by firm, what I called dispatchable generation. So the industry needs that signal.
There are hard questions because the next round of exits are in 2022-2023. It is why the focus is so much about how can a Liddell stay. Without this, unfortunately, we will be left with a range of short-term solutions that will actually potentially fix today but will not actually recognise the fact that the amount of investment that needs to flow to manage such a significant transformation. It’s just difficult for me to see how that can be achieved without a signal to help private capital and private investment over time working.
At the moment we’ve got a 2030 target, which many agree is not enough to avoid the worst impacts of global warming and nothing beyond that. We know that that does not serve the customers and the community, or the planet in the long-term. Thank you very much, ladies and gentlemen it’s been a pleasure to share those thoughts with you today.
This is an edited transcript of a speech by Origin Energy CEO Frank Calabria to the Committee for Economic Development of Australia on 25 October 2019