3 June 2014
Pre-conditions for sound energy policy in a period of rapid change
Origin's Chief Executive Officer Energy Markets, Frank Calabria presented at the CEDA Energy Series event on Tuesday 3 June, 2014.
Thank you for the opportunity to speak today alongside Peter and John.
Today I’ll be covering three areas
- The structure of the energy market and some of the changes affecting it
- The pre conditions necessary for sound energy policy
- What those policies might aim to achieve in the current environment.
The value in getting NEM policy settings right, and the costs of getting them wrong, have never been more pronounced for our industry and our customers.
Ministers, bureaucrats and the energy market institutions – including John – have a huge challenge in balancing trade-offs between delivering competitively priced and reliable energy while reducing emissions over time.
But seeking to deliver these policy priorities also occurs during a period of change to our operating environment, and so energy policy needs more than ever to remain relevant, robust and effective.
1. Energy Market Structure and Changes
Let me begin by examining looming activity and change affecting the energy sector.
In the next six months or so, we will see, or will likely see:
- The deregulation of New South Wales electricity prices;
- The repeal of the Carbon price;
- An initial pathway forward to deregulate Queensland electricity prices;
- The release of the Government’s Energy White Paper;
- The release of the Expert Panel’s review into the Renewable Energy Target – and the release of the Government’s response to this review;
- Regulatory reviews well advanced in Queensland and New South Wales, which will set network prices for the next five years.
This policy work is occurring alongside a Victorian state election in November, New South Wales state election in March and Queensland state election in the first half of next year.
This is a huge amount of activity and change. In this context, I think our energy policy makers – at both the state and Federal level – do a good job in what is a very challenging environment.
I’d specifically like to acknowledge the South Australian, New South Wales and Queensland governments for following Victoria’s lead in progressing price deregulation. These are important developments that deliver real benefits to customers, remove unnecessary risk for the industry, and aid in our ability to manage external change.
No discussion of long term priorities is complete without considering how the shift in the supply/ demand dynamic is shaping energy markets.
To show how quickly our demand expectations have changed, we should look to the AEMC’s Strategic Priorities for Energy Market Development – released in April 2011.
Based on AEMO forecasts, it projected 2.3 per cent average demand growth and 2.6 per cent peak demand growth per annum out to 2020.
Despite these forecasts, most of us are acutely aware that aggregate demand in the NEM has declined each year since 2009.
NEM demand for the 2013/14 year is forecast to be around 186 terawatt hours versus 198 terawatt hours in 2009/10. The challenge for energy policy in an environment of falling average demand is how to efficiently utilise existing capacity, and this invites a discussion on whether predominantly volume based tariff structures are still useful for recovering costs.
In the past, most electricity system revenue has come from volume based charging – a tariff structure that is less appropriate in the current environment. Consequently, over the last five years the industry has been faced with recovering a return on a significant fixed capital base from a declining pool of volume – leading to rising unit costs.
The phenomenon of falling demand has occurred alongside a rapid increase in distributed generation.
Today, we are seeing installations of around 50 MW of solar PV per month.
In June 2010, there was NEM installed PV capacity of around 263 MW. By June 2014 we expect there to be installed capacity of around 3,087 MW – representing more than one million systems.
This means that over four years almost 3,000 MW of additional capacity has come into an already oversupplied market that is experiencing falling aggregate demand. If the market was operating as it should, the wholesale price of energy would signal to the market that it is oversupplied and that new capacity was not needed. The wholesale price of energy – which absent other interventions would signal whether new generation investment is required and provides a general sign of the supply demand balance – was $40 MW/hr in 2009/10 versus around $54 MW/hr in 2013/14.
Adjusting to account for the addition of carbon during this period, we actually see that the underlying wholesale price of energy has fallen from $40 MW/hr in 2009/10 to around $32 MW/hr in 2013/14.
The low wholesale price clearly shows that the installation of this 3,000 MW of PV capacity has been driven by an external intervention and isn’t due to investment signals provided from the energy only NEM wholesale market.
This investment is instead being incentivised through a range of subsidies – some transparent and others less so.
The cost of deploying these technologies was highlighted again by the Queensland Competition Authority last week – showing that the Queensland Solar Bonus Scheme makes up 7 per cent of an average electricity bill in Queensland, and will peak in 2015/16 when it will comprise 34 per cent of Energex’s network prices. The deployment of distributed generation also heightens the need to progress tariff reform, and for Governments to play their part in the orderly unwinding of cross subsidies, to ensure relevant assistance is directed to the most vulnerable in our community.
2. Pre-conditions for sound energy policy
In light of the scale of activity and nature of the changes confronting participants and investors in the energy sector, I would like to highlight three critical factors necessary in developing sound energy policy that is to remain relevant in a period of change.
In short, I would summarise these pre-conditions as:
- Governance; and
Sound policy development requires transparency and clarity around who bears risks and costs of changes to policy settings.
There must also be transparency around the costs of subsidies impacting on the energy sector.
Investors in generation capacity face the full costs associated with reduced demand, while in the future under 9 a regulated revenue model, other parts of the value chain will be provided with a regulated return that insulates them from risks associated with falling average demand.
Likewise, owners of non-subsidised generation plant have also borne the costs associated with subsidised supply that has been brought into the market due to investment incentives outside of the energy only NEM market settings.
It is important that there is a degree of transparency around both the size of the wealth transfer and who is bearing the costs and benefits of these policy settings and interventions.
In this context, and further to my earlier comments on the need to progress tariff reform, I also draw your attention to important work the Energy Supply Association of Australia has done highlighting the implicit subsidy afforded to the owners of some forms of distributed generation through the avoidance of cost reflective network charges.
We all need transparency around these subsidies so policy makers can make informed decisions around policy and regulatory settings.
The need for informed decision making brings me to the issue of governance around energy policy development.
My thinking here echoes John’s AEMC submission to the RET Review Expert Panel.
Too often in recent years we have seen material climate policy decisions made without reference to the appropriate energy policy expertise, and with little regard for the impact on the energy sector.
Here I think of policy interventions such as feed in tariffs and the Renewable Energy Target – including the decision to split the LRET and the SRES.
The key lesson here is that responsibility for decisions that materially affect the energy sector require proper input from energy policy specialists and investors – to do otherwise means decisions are taken without proper understanding of the impacts on energy sector investments.
Finally, I suggest that a degree of flexibility is necessary in a period of rapid change to allow policy makers to respond to external conditions.
For instance, recent conditions of declining average demand have led to a conversation about orderly retirement – a topic unimaginable only five years ago.
We have seen the AER and AEMC respond to the pressures of network-driven energy price rises. We expect to see outcomes that benefit consumers as a result of new regulatory determinations periods for New South Wales and Queensland electricity networks beginning on 1 July 2015.
Investors recognise that policy settings will change over time – and in an environment of rapid external change, flexibility is required to ensure settings stay relevant. The pre-conditions of transparency, proper governance and flexibility should help provide for sound energy policy development. They help policy makers balance trade-offs between delivering competitively priced and reliable energy while reducing emissions over time.
With this in mind, I will conclude by touching on a number of key policy issues.
3. Policy Priorities and What They Can Achieve
Good progress is being made in progressing necessary reforms in the retail market to move to price deregulation where competition is effective.
However, with respect to the wholesale market, I have highlighted that there are a range of interventions distorting the investment signaling functioning of the energy only NEM.
It is important that over time policy makers allow the NEM wholesale market to function effectively – and this includes ensuring proper thought is given to the energy sector implications of climate policies.
The Renewable Energy Target is one intervention affecting energy sector participants and consumers. Origin believes that the Renewable Energy Target should be adjusted in light of current circumstances and we believe the sustainability of the NEM – and the RET – will be 13 enhanced by moving to a true 20% target.
This ensures that existing projects that are committed or under construction can be completed, while avoiding issues of sovereign risk. It also removes some of the cross-subsidy cost burden on households and businesses.
Likewise, I have today highlighted how the concurrent trends of declining average demand and significant deployment of distributed generation heighten the need for policy makers to focus serious attention on the issue of tariff reform to deliver cost reflective pricing and ensure tariff structures aren’t subsidising some users at the expense of others.
Sound energy policy is not about achieving consensus, but rather about achieving balance – and that balance is only possible when the process and its outcomes are well informed, transparent and flexible - particularly in a changing external environment.
Thank you for the opportunity to contribute to this important discussion.
Chief Executive Officer, Energy Markets