Wholesale price debate reignites

The Victorian Energy Policy Centre released a paper into wholesale prices following the closure of the Hazelwood power station this week.

An assessment of this period and the changes in capacity and price bids in the market following the closure of the Victorian power station is not new – it has previously been undertaken by the Australian Energy Regulator[i] (AER).

What is new and different about the work from the VEPC is the fact that it claims the exercise of market power as the prime driver. Those findings are very different to those found by the AER, with two decades of experience in interpreting bidding information.

Background

The 1600 MW Hazelwood power station in Victoria’s Latrobe Valley closed on 31 March 2017 with only a few months notice. The power station had been responsible for generating more than 20 per cent of Victoria’s electricity and an estimated 5 per cent of the National Electricity Market’s (NEM) output. As noted following the closure the weighted wholesale price average in the NEM increased from $52 per megawatt hour to $96/MWh in the calendar year after the plant closure.

The closure drove an increase in the need for NSW generation and consequentially higher demand for black coal.

In September 2017 the then-Federal Energy Minister, Josh Frydenberg, requested the AER take a look at NSW wholesale prices. This followed a media report claiming opportunistic pricing had pushed up electricity prices[ii].

Confluence of Events

In its report on NSW prices the AER advised that it had not seen the sorts of opportunistic bidding it would associate with exercise of market power. It did point to reduced competition in NSW because the state’s ability to import low cost brown-coal power from Victoria following the closure of Hazelwood was reduced. At the same time there was an increase in gas prices which restricted generation from gas-fired plants, as well as hydro adjusting market offers to ensure supply for the peak summer periods.

In fact a confluence of misfortunes in the cost of production of electricity occurred, and, as per the market design, wholesale spot prices rose to reflect these challenges.

The AER pointed to coal supply issues and an increase in the price of coal as major factors. The December 2016 and March 2017 prices sat at around $110 per tonne (around $47/MWh), compared to the 2015-2016 average of $71 per tonne. The globalCOAL Newcastle coal price also increased further later in 2017[iii].

The tightening of supply due to the Hazelwood power plant closure was always going to lead to increased wholesale prices until investment in replacement, dispatchable plant occurs. But this happened in a period of heightened public and political focus on power prices, which continues with this latest VEPC assessment gaining broad media coverage. Fortunately the forward price of electricity suggests this challenging circumstance is easing.

In its paper the VEPC assessed the extent to which “the observed outcomes when coal-fired generators set market prices are consistent with a model of oligopolistic competition”.

The paper does not accept that there were shortages in production capacity that would justify the higher prices that were seen and overall points the finger at AGL’s Bayswater and Liddell power stations.

The VEPC paper states that: “There can be little doubt that the higher prices when coal generators were setting prices cannot be explained by scarcity of production capacity, because such scarcity rarely existed.”

It notes that coal-fired generation capacity was repriced into higher price levels following the closure of Hazelwood and that AGL’s Bayswater and Liddell power stations concentrated output during daily peak demand periods but reduced this overnight and in the middle of the day – low demand periods.

Firm Disagreement

However AGL firmly disagrees that this occurred due to anything but explainable physical circumstances. Coal constraints at Bayswater and Liddell had limited their ability to increase or maintain their production[iv]. As noted by AGL, when coal supply is constrained, aligning your generation with times of the day it is needed most reduces reliability and risks[v]. It makes sense. Generation during high demand periods remained consistent before and after Hazelwood’s closures, and this is consistent with ensuring supply to match when it is most needed.

Falling stockpiles led NSW generators to manage their dispatch to avoid the risk of not having sufficient supply during the peak demand months. There were serious concerns about supply availability reported publicly[vi].

Coal generators had issues with coal stockpiles and the AER reported that confidential information it received from generators confirmed that stockpiles were significantly lower than historic levels. This is partly due to the power stations correcting for the historical over-purchasing of coal before Hazelwood’s closure[vii]. 

Following the Hazelwood announcement many generators had to obtain higher priced short term contracts, but stockpiles did not recover.

In a supplementary submissions to the ACCC’s electricity pricing inquiry, AGL indicated that up until October/November 2016 its operation of the former Macquarie Power Stations (Bayswater and Liddell) was predicated on large existing stockpile and generation levels that assumed Hazelwood was still in operation. It reported it had difficulties getting coal onsite for Bayswater and Liddell over a 12-month period.[viii]

It also reported that in FY17 it had consumed more coal than was delivered, and as a result drew down its stockpile and rationed its coal.

Amongst other factors were failure to receive deliveries of coal due to a contractual dispute, extreme heat and high demand in February 2017 that resulted in its coal stockpile being drawn down.

Further confounding these issues, bushfires impacted the Australian Rail Track Corporation’s rail network during September 2018 with a cancellation of trains, as well as scheduled outages on the rail network, and increased marginal coal costs such that prices nearly doubled. All resulted in a “rapid drawdown on stockpiles” with AGL seeking to ration its coal.

AGL’s was reported to have a stockpile of 4.2 million tonnes at the time that the NSW power plants were acquired and these stockpiles had reduced to 1.6 million tonnes at the time of Hazelwood’s closure.[ix]  AGL has commented that at “the lowest point in mid-2017, the stockpile was at a level which would only have enable about four and half weeks’ worth of production.”[x]

Why does this mean bids increase?

Generators ration limited fuel by raising bid prices, thereby reducing the plant’s operation in order to avoid a more serious shortage later. The market design intends for this process to occur. For example, hydro plants must bid much higher than their fuel cost (which is zero) to ensure they do not run down their water storages ahead of the peak demand time.

Indeed it could be said that the market’s rationing process has worked very effectively in avoiding a crisis that might have occurred considering the unexpected shocks upon a very limited coal supply.

AGL’s total generation output has been stable for the past three financial years at around 45.5TWh – this includes power stations in other states, which increased output and offset some of the challenges in NSW black coal fuel supply.

However the VEPC does not accept that AGL’s two NSW coal-fired power stations were materially affected by coal constraints, while acknowledging on page 39: “Without access to the confidential information provided to the AER and ACCC, it is not possible to assess AGL’s claims.”  It then goes on to claim other “evidence” to dispute the constraint issue.

Conclusion

Higher wholesale power prices will continue to attract intense focus given the heightened political and public debate about energy costs. Tighter supply following the closure of the Hazelwood power station did lead to higher spot prices - it is consistent with how the NEM is intended to respond. It both rations the fuels that are in shortage and signals the need for more generation.

There were a range of factors involved and wholesale prices rose to reflect those challenges. In its most recent review of wholesale market performance, the AER did not identify short term behaviour as a significant factor contributing to recent energy price rises, but it did flag longer term trends that it will continue to monitor and that will require time to properly assess. Proper and careful assessment is critical in such a highly charged environment.

It is also worth considering the excellent work prepared on behalf of the Australian Energy Council by Rajat Sood that discusses hypothetical questions of market power in a changing power system (a copy of his report is available here). Whether or not you consider the existing market to be sufficiently competitive, technology changes are in the process of completely altering the frame of reference for considering competitive market structures.

[i] AER electricity wholesale performance monitoring, NSW electricity market advice, December 2017; AER electricity wholesale performance monitoring, Hazelwood advice, March 2018; AER Wholesale electricity market performance report, December 2018.

[ii] “AGL, Origin bidding up power spot prices, says Schneider, The Australian, 29 August 2017

[iii] AER NSW electricity market advice, December 2017.

[iv] https://thehub.agl.com.au/articles/2019/03/coal-constraints-in-nsw-and-energy-prices-following-the-sudden-closure-of-hazelwood

[v] https://thehub.agl.com.au/articles/2019/03/coal-constraints-in-nsw-and-energy-prices-following-the-sudden-closure-of-hazelwood

[vi] “Glencore industrial dispute putting pressure on NSW coal supplies”, Australian Financial Review, 20 September 2017;

[vii] “Market manipulation claims welcomed”, Australian Financial Review, 26 March 2018

[viii]https://www.accc.gov.au/system/files/AGL%20%28supplementary%20submission%20-%20NSW%20coal%20supply%29.pdf

[ix] “Market manipulation claims welcomed”, Australian Financial Review, 26 March 2018

[x] https://thehub.agl.com.au/articles/2019/03/coal-constraints-in-nsw-and-energy-prices-following-the-sudden-closure-of-hazelwood