Once again I find myself calling for the head of the manufacturing lobby’s CEO. Today Innes Willox spoke:
We had cheap energy for a few reasons. Firstly, fuel was cheap. Black coal, brown coal and natural gas resources were huge relative to domestic demand. They were easy and cheap to produce. Fuel was often supplied by State-owned enterprises or according to State-set contracts on gentle terms and prices. And crucially, most of this fuel was isolated from international markets. All Eastern Australian gas, all brown coal, and most black coal was captive to local consumers. For local energy users, the price of gas in Japan was about as relevant as the price of tea in China.
Secondly, we had a lot of capacity relative to demand. State electricity authorities built and built and built, at a time when building things was in many ways cheaper. Governments were focussed on jump-starting industrial development. The costs were more likely to be squirreled away in Budget documents than found on users’ bills. The National Electricity Market and the wider corporatisation and privatisation efforts of the past two decades have delivered remarkably low wholesale electricity prices until recently, in significant part by sweating a generation fleet well in excess of what private investors would have built on their own.
Thirdly, we didn’t perceive or apply much in the way of environmental constraints to energy. Local objections were mild because from the mid-20th century most of the power was produced well away from big cities, and the gas came from offshore or the desert. Climate change and greenhouse emissions were barely on the agenda until the late 1980s.
What happened
Obviously a lot has changed. This time last year gas prices offered to industry were as much as $24 a gigajoule, and while they’ve thankfully slipped back from that apocalyptic level, members are still being offered as much as $14 and there’s a widespread expectation that wholesale prices will float in an $8-$12 range over the long term.
Wholesale electricity prices have more than doubled, averaging around $100 a megawatt hour across Eastern Australia in 2017. While futures prices decline over the next few years, they only drop to around $70.
These changes have been incredibly painful for industry, and they still are: businesses entering the market this year to replace two- and three-year-old contracts are still gobsmacked by the scale of price increases, despite the improvement since early 2017. Why has this happened? Our take is pretty simple.
Gas prices went up because the market was utterly transformed by Liquefied Natural Gas exports. Export demand required production to triple, with nearly all of the new supply coming from Coal Seam Gas with higher production costs than older conventional resources. Producers now expect export parity pricing. And demand ramped up so fast that production seems to have struggled to keep up, bringing scarcity pricing for a while.
Electricity prices went up because higher gas prices raised the operating costs of gas-fired generators, and because the role of those generators in setting wholesale electricity prices grew even larger with the closure of a lot of coal-fired capacity. Victoria’s Hazelwood attracted a lot of notice, as did Northern here in SA. But Hazelwood was just a quarter of the capacity that has exited since 2012, as clapped out old plants approached end of life and investors gave up after years of low prices.
So far so good. But then Willox turns to what should be done:
Fuel costs have shifted permanently. We still have lots of coal and gas – more gas than we ever knew we had before. But most black coal is now exposed to international trade, and the old low-ball State supply contracts will not come back. All the new gas supply options either have substantially higher production costs than the old conventional oil and gas wells, or higher transportation costs – and the expectation of export parity pricing is not going away. International linkage is a fundamental transformation of our energy markets. Brown coal remains isolated – though the dream of converting it into an exportable product lives on in hydrogen, and could yet unseat our assumptions – but here capital costs and climate are the barriers.
The costs of building new-for-old replacements for our current coal generation fleet would be substantial, to say the least. The lowest estimates we’ve seen for the costs of new black coal are still 50% above the long term NEM average price, and they are so reliant on sweetheart below-market fuel supply assumptions and unlimited 6 government guarantees that they are hard to take seriously. New brown coal would be just as expensive, despite cheaper fuel, because the capital cost is so large.
And climate change policy isn’t going away either. In Paris in 2015, Australia committed to join international efforts to limit climate change to well below 2 degrees above pre-industrial levels. Like other countries, we offered a relatively cautious initial commitment to cut emissions 26% below 2005 levels by 2030. That is a big change in itself, but the Agreement envisages successive recommitments by all nations that bring global emissions to net zero by the end of the century. And Australian State Governments of all persuasions have already made commitments of their own to hit net zero by 2050, just three decades from now. In an industry where many assets built now will outlive that target, long term climate policy is part of the here and now.
Is that it, then?
Rebuilding the same advantage we had in the past is not possible – we could build the assets, but they would not deliver us back to competitiveness.
That cannot be the end of the story, however.
We still have huge energy resources of every sort: wind, solar, uranium and hot rocks, as well as coal and gas. We can still aspire to turn all of those resources in to useful energy where the costs make sense, and to do it as well as anyone in the world.
Right now it looks increasingly like renewables will dominate our energy future. The levelized cost of energy from wind turbines and solar photovoltaics keeps falling, blasting through expectations that the rate of innovation would slow as technological maturity sets in.
• The performance of wind turbines continues to improve; ever vaster structures on- and off-shore can deliver more and steadier power at a lower price.
• Solar PV has seen sustained price reductions in the most boring and well-established silicon technology, thanks to scale, learning and China; new materials and configurations are likely to drive prices down even further.
These energy sources remain variable, and that variability remains a very significant challenge as renewables increase their share of the electricity system. Wind and solar PV already have the lowest levelized cost of any new generation option – but the key to competitiveness is whether we can turn that intermittent abundance into cheap power when we want it.
It’s clearly physically doable to firm up a renewables-heavy energy system with dispatchable generation, storage and demand response. But how cheaply we can do it remains unclear.
• Gas generation is a terrific source of flexibility, mature and available now. But the fuel is not cheap – we are not going to have a cheap power system if gas meets a lot of the volume of electricity demand.
• Pumped hydro is big and well understood. I’m not sure that there’s a lot of cost-reducing innovation to come in building dams, drilling tunnels and sticking turbines in them. And building big things near national parks – or in them – does not sound easy.
• Batteries are clearly on a solar-style cost reduction pathway, and are already playing a cost-competitive role in some niches. But they will have to get a lot cheaper to play a big role in solving daily or seasonal energy-shifting challenges. Perhaps widespread take-up of electric vehicles will change the game still further: auto industry scale will bring a lot of learning and innovation, and millions of cars sitting around all day could be a cheap storage resource for the electricity system.
• Demand response has got headwinds to fight against – energy suppliers have until recently seen it as marginal or contrary to their interests, and most users haven’t been attractive. But the basic logic is compelling: for those fractions of the year when the system is under the greatest strain, it can be a lot cheaper to stop using something you’ve already built, than to build something new that will sit idle nearly all the time.
In short there is a plausible vision for an energy system that is both heavily renewable and cheap. We’re not guaranteed to get there, and we should not close ourselves off from other possibilities. Gas doesn’t seem like it is going to get cheap again, but Americans may have thought the same thing in the early 2000s. New generation nuclear technologies could finally fulfil the dream of mass production and cost reduction. Maybe a bolt from the blue will come along, like fusion or orbital solar.
Earth to Willox. The east coast of Australia already has a domestic reservation mechanism that is sitting idly on the shelf. The obvious solution for gas and electricity-intensive energy manufacturing is that the government pull the lever and halve the gas price. WA has it and has $6Gj gas.
We have a federal election no more than one year away and if this government can’t be made to see sense on reservation using its own tool then the incoming Labor government might. It is a free kick for Labor to install more stringent gas reservation using the Coalition’s own legislation, providing immediate energy price relief to households and business across the east coast.
This is very basic political economy analysis that throws up an obvious play for the manufacturing lobby to scream from the rooftops about the need for gas reservation now and over the next year.
Instead Willox gives us the above total capitulation to the gas cartel.
You’ve need the arse, mate.
