Economics and finance, Environment & energy, Trade and industry | Australia

13 July 2022

To address its energy crisis, Australia could protect its energy market from global disturbances, facilitate fuel switches, invest in storage, and protect consumers, Roc Shi writes.

On 15 June this year, the Australian Energy Market Operation (AEMO) made history when it suspended the national electricity market (NEM). It explained that price caps in the market, coupled with significant unplanned outages and supply chain challenges, were leading to generators removing capacity from the market.

The unprecedented event, however, was not intended as a permanent solution to the current energy crisis. The operator noted the array of problems plaguing the NEM that the country must address if it hopes to normalise its energy situation.

As a major supplier in the global energy market, Australia’s crisis is not due to a lack of supply. At the heart of this issue are affordability concerns. The Australian market is well-connected to global energy markets and so its consumers are feeling the flow-on effects of global disturbances.

Rising energy prices are a market reality across the world. The Brent oil prices, a world benchmark, increased from $74 per barrel a year ago to $119 per barrel on 16 June 2022 when NEM was suspended.

The Japan/Korea Marker, a spot price benchmark for gas in East Asia, increased from $3 per million British Thermal Units – a measure of the energy content of gas – in July 2020, to $13 in June 2021, to $38 in June 2022, up twelvefold in less than two years.

That said, Australia cannot hide from failures of its own policies to ease this burden.

The failure of the NEM to generate sufficient supply is primarily due to unreasonable price caps and other policy failures. Faced with generating electricity at a loss, generators are forced to withdraw their bids to sell electricity and stop generating – a rational market behaviour.

This situation, where power generators trim down their production capacity despite an increase in power demand, also occurred in China later last year. One proposed solution is to fast-track electricity market reform so that the electricity market can incentivise peak generation.

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Various options are available to do this in Australia to address the energy crisis.

The first is to take steps that incrementally separate the Australian markets from world markets. Because Australia is a net exporter of coal and natural gas, it can limit its exports. This may not be in line with the market principle, but neither was the NEM suspension.

The exiting Gas Supply Guarantee mechanism, or a possible gas reservation policy as in Western Australia, can restrict gas exports already, but for coal, the government would need to add a new regulatory instrument – it should do this.

This will not solve the problem alone though. Whether low gas and coal prices can lead to low electricity prices for the consumer depends on transmission and generation capacity, which is also currently in shortage.

The second option will be to facilitate fuel switches. Switching from coal and natural gas to renewables will be an obvious choice, as renewables do not consume fuels and thus are immune from global energy market changes.

It is important to note however, that AEMO has flagged stability issues within the Australian grid if more storage for renewable energy and firming capacity – flexible energy supply that can be activated to top up supply during periods of peak demand – isn’t secured to support the switch to renewables. Its estimates show firming capacity would need to triple by 2050 to facilitate this.

This is the third option – to invest heavily in advancing that storage capacity, with more projects like Snowy Hydro 2.0, which will have a total capacity of 350,000 megawatt hours when it is completed in 2028.

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AEMO has also recently been empowered to operate the national storage of gas. While current storage technology is often effective in managing short-term volatility, more storage capacity will be needed in a renewable dominated power system.

Another less desirable, but possible, fuel switch is to switch some gas generation to coal generation. Coal power is often cheaper than gas power, and this cost advantage has been more significant during the past year or so as global gas prices have soared.

However, due to a lack of investment in new coal-fired generation since 2012, Australia currently has to rely on its ageing coal-fired power stations – at least 25 per cent of which are offline due to scheduled or unscheduled outages – to provide firming capacity.

The Australian public may have to accept that coal and natural gas generation capacity will have a role in Australia’s energy future for a long time to come.

Coal and gas generation is a cheap way to provide the flexible firming capacity that provides a renewable-dominated grid with crucial ‘top ups’ of energy during increasingly common peak demand events like heatwaves. A capacity mechanism proposed by energy ministers is one way to secure such backup.

The fourth option is to protect the vulnerable without distorting energy markets by providing energy rebates or other assistance to low-income households, a practice that has been implemented in multiple states, but could be rolled out nationally.

Any solution of sufficient scale will involve the redistribution of wealth, but given that the coal and gas exporters will receive windfall profits, tax mechanisms similar to the United Kingdom’s windfall tax could be used to finance them.

Overall, Australia needs to enter an inclusive and realistic debate about its energy transition plan that considers these ways of ensuring secure and affordable energy during its transition to net-zero. Australia should not preclude any policy, or technology, from its deliberations as long as it facilitates progress toward that goal.

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