Jun 15 2022

A post-blame explainer of the current energy crisis

In times of crisis, it can be strangely satisfying to have someone to blame for it: a mistake, a villain, a government, a company. The bigger the crisis, the bigger the need to hold someone responsible. 

Australia and the world are reeling from the most serious global energy crisis in decades. The imposition of economic sanctions against Russia following its invasion of Ukraine has created a global energy shortage. Europe was already facing tight energy supplies as below average wind generation for much of 2021 had forced it to use up much of its gas reserves. 

Imposing sanctions on Russian oil, gas and coal has created major economic headaches in Europe, as they have few alternative suppliers. The aggressive re-contracting of available energy supply chains has sent global prices for these fossil fuels to record highs. 

This price shock wave has now reached Australian energy markets, with spot market prices for black coal above $500 per tonne and $40 per GJ for gas. These prices are four to five times the long-term average. 

These high fuel prices have driven up the price of electricity, as generators have had to compete with these international spot prices to buy some of their fuel. Coal generators are more exposed to spot prices now because they have been reducing forward-contracting in anticipation of continued increases in renewable generation. That’s how the transformation was supposed to work. 

This price spike hit Australia at the same time as a fierce June cold snap, following two months of low wind generation, reduced coal stockpiles, and heavy rains slowing coal mine output. Solar output is below average due to the shorter days. 

The cold weather has exacerbated the problem by increasing demand, which made the energy shortage more acute. On top of this there were unscheduled outages in some coal generation units. The disruption to global supply chains is causing delays in getting essential parts to fix these units. It has been a combination punch of shocks: global energy shortage, increased exposure to spot prices, cold, wet weather and unplanned, prolonged outages. 

Is the NEM broken? 

The short answer is no. The long answer is recent events have revealed the need for some simple, but important repairs. 

The combination of all these energy shocks resulted in more than a week of very high wholesale electricity prices. When this happens, it triggers an automatic price cap mechanism in the National Electricity Market. As the name implies, this caps wholesale spot prices at $300/MWh. 

This price cap mechanism was designed when the NEM was created in 1998 to manage short term events like summer heat waves. Longer term global energy shortages like now were not anticipated. Sustained higher wholesale prices are the market solving for the combination of problems it faces: high demand, some units unavailable and the need to ration scarce coal at some power stations. 

Additionally, the cap price has not been updated in more than 20 years. It was originally designed to reflect the maximum price a gas peaker would need to recover its costs. But with gas prices currently at $40/GJ (which is also an artificial cap, so we know that’s as high as it can go), this ceiling would need to be around $500/MWh to ensure all generators can cover their costs. 

While coal is typically cheaper than gas, its problem is the currently constrained fuel supply. The coal rationing is critical, because coal generators need to run all the time, but want to make sure they have enough coal for the demand peaks in the mornings and evenings. So they deliberately bid in higher prices at other times to bid themselves out of the market. This lets them save more coal for when it is needed and lets generators with more coal take up the slack. It’s an oddly elegant way the market solves for the third dimensional problem of coal scarcity. 

When a price cap is introduced this coal rationing regime doesn’t work. Under the market rules, a generator that has bid in must be fully utilised before the Australian Energy Market Operator (AEMO) can direct other generators to turn on. This inadvertently discourages generators with low coal reserves from bidding in at all. Once directed on by AEMO they can work together to manage limited coal stockpiles to optimise output. 

The problem here isn’t the generators withdrawing units. The problem is that the automatic price cap is interfering with the market doing its job and complicating the way generators are paid for doing the same thing. This response to the price cap has not increased the risk of outages or impacted on prices paid by consumers. If anything, it has helped reduce reliability risk. 

The answer is to either remove the automatic price cap and let the market solve (as it was doing), or at least increase its value, or agree on conditions that trigger AEMO dispatching all generation, so that it can co-ordinate market dispatch under extreme conditions. 

AEMO yesterday chose this latter solution, by suspending the NEM indefinitely. It’s a radical step, reflective of the extreme market conditions. A suspended market is better than where we were before: where some generators were in the market while others were being directed. 

High energy prices and increased reliability risk are bad for the economy and bad for consumers. They are hurting many small energy retailers and exposing the frailties of both relying on and demonising our ageing coal fired generation fleet at the same time. 

We need to do everything we can to resolve this crisis as quickly as possible. Australia’s energy industry will continue to work with governments, agencies and other stakeholders to achieve this. 

It’s understandable that people are concerned about this latest event in a series of ever escalating energy bad news. It’s easy to apportion blame. It might help if we understood what was actually going on first before taking the moral high ground. 

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