The typical new solar or wind farm project has a forecast operating life of 25 to 30 years. In this context, when looking at the current policy confusion surrounding electricity/emissions abatement policy it pays to take a long-term view. The following table summarises the key phases in the development of electricity and renewable energy policy over the past few decades.
1980s and before“State owned era”
Electricity system developed by State government owned electricity companies as an essential service on a vertically integrated basis. No material private ownership of grid connected generation capacity.
1990s “Privatisation and Deregulation”
Creation of national electricity market.Separation of generation, transmission & distribution and retail.Privatisation across broad parts of the NEM (but not everything and not everywhere).
2000s “start of renewables – high cost phase”
Renewable Energy Target (RET) introduced. Objective for 20% of generation to be sourced from renewables by 2020. The RET is a subsidy mechanism, funded by electricity consumers, that effectively forces 20% renewable generation into the system (over a 20 year phase in period). However, at this point renewables costs are very high (over $100/MWh on a levelised cost basis) and the initial phase in schedule to the 20% target was very gentle. Thus, very little new renewable generation was built.
2010 - 2015 “start of the climate wars”
An era that started with the introduction of the Carbon Tax and perhaps ended the Warburton review and talk of abolishing the RET.
· Carbon emissions were put firmly on the agenda for investors. After this no investor considered a generation investment without full consideration of potential future carbon taxes in the base case. This was when coal based generation became uninvestable. Even if the carbon tax had been abolished – there was no sense amongst investors that this was forever. The world still needs to decarbonise and some future government is likely to put a price on carbon. From now on no rational investor in the private sector was going to make a decision to build a brand new coal plant.
· Renewable energy was still very expensive. Given uncertainty and high costs relatively little was built (and Australia was way behind the RET targets).
2015 – 2019 “renewables phase 2 – low cost renewables meets high LGC price"
Malcolm Turnbull becomes PM. There is bipartisan deal to retain the RET. LGC prices explode higher to $80. Energy prices are also pretty high – particularly post the closure of Northam and Hazelwood power stations.
High prices for renewable generation – merchant projects were earning $100-150/MWh on a bundled basis – intersected with rapidly falling construction costs (particularly for solar). Based on short-term prices, projects were extremely profitable, we were seeing projects offering a cash yield on build cost of 15-20%.
New renewables development exploded – flooding the market - with the consequence that revenues – both energy and LGCs have subsequently fallen sharply.
Falling revenue expectations, grid constraints, continued policy uncertainty, rising EPC costs (on a falling dollar and following EPC failures) have all seen the profitability of new renewable projects decline sharply and, hence, a rapid decline in new projects reaching financial close.
In parallel with the renewables boom it has been a challenging era for existing fossil fuel plant. Revenues have fallen – after the short peak around the closure of Hazelwood – as new supply of bulk renewable energy has flooded into the market. Gas and black coal prices have been reasonably high and so this has squeezed the profitability of existing fossil fuel generators. For gas plants, in particular, they have been effectively relegated to only being profitable (relative to fuel costs) during relatively short peak periods.
While peak pricing has remained high, prices at non-peak times, particularly during the middle of the day have fallen sharply.
This is a quick run through 30 years of history – but what comes next?
The focus amongst politicians and policy makers has shifted from emissions abatement (RET and carbon tax) to a focus on price/reliability. Interventions, such as Snowy 2.0 and UNGI (underwriting new generation investment) are focused on the subsidisation of new capacity to improve reliability. While the specific projects which receive funding may boost capacity, the net effect is much less certain, as the unclear and uncertain policy framework discourages all investment.
Noting that all forms of utility-scale generation are long-life high upfront cost investments, from an investment perspective, all generation sectors are struggling:
Renewables – the RET has been met and so LGC prices – in NPV terms – don’t provide much of a boost for viability. For many projects it is difficult to secure a PPA that reflects their levelised cost of production.
Storage – while battery costs have fallen – making storage more viable for some applications (most notably grid stabilisation and short duration activities) – it is still very difficult to make an investment case. In particular, everybody who invests in batteries today needs to consider the risks of competing against the much cheaper batteries that are likely to be available in three to five years.
Fossil Fuel Generation
Gas fired plant faces three challenges: gas price risks (gas has fallen sharply in price, but prices aren’t expected to stay this low forever), future carbon taxes, and the threat of cheap batteries (many analysts expect batteries to be able to outperform gas plants in 5-10 years).
Coal generation plant: as noted above a new build coal fire plant can’t compete on a levelised cost basis with other forms of generation in the current marketplace. This is before any concerns regarding any future pricing of carbon emissions.
Behind the meter solar - the economics of behind the meter solar continue – the cost of equipment continues to fall, but network costs (tariff structures) remain the same, thus network arbitrage continues, and for households, electricity costs continue to fall. For utility-scale generation the net effect of behind the meter solar is to hollow out daytime demand.
All of this suggests an environment where new utility-scale capacity development will slow. At one level, this probably isn’t a bad thing, because demand isn’t growing (particularly net of rooftop solar). However, if you take a very long-term view and, perhaps add in an optimistic squint (or some rose colored glasses), there are some grounds for optimism:
· The majority of Australia’s coal fired generators will need to be replaced in the next decade or so. This should provide an impetuous for an improved policy framework.
· Covid-19 and the ensuing economic upheaval will likely reduce the impetus to address climate change in the short-term, but nothing has changed in respect of climate change itself (e.g. temperature extremes in the artic last week), and as the climate situation worsens this will drive policy towards carbon emission reduction.
The political environment regarding emissions reductions is terrible and this is a huge road block on the development of efficient policies to effectively reduce Australia’s total carbon emissions. The positive thing is that this is so bad that it is almost inevitable that this will improve over years (and hopefully not decades) ahead.