Key Energy Review - June 2018


Welcome to our newsletter ... and an increasingly complex energy market.

One of the more perplexing facets of this business is responding to client requests for a forward view of the energy market. Beyond the short to medium term, i.e. that period covered by the ASX forward market it is simply impossible to say anything definitive.

It is common to see wordy predictions of electricity prices out until 2025 that have a 50% variation between the low and high cost scenario. Many words, few bankable facts. Given the uncertainty surrounding the National Energy Guarantee (NEG) this level of confusion is not unexpected. Hopefully, the background below will help explain some of the challenges. As usual, further information about current energy prices or anything else dealt with in this newsletter can be obtained from info@thekeygroup.com.au or phone: (03) 9885 2633.

The Finkle Review is now done and dusted. Forty nine of the fifty recommendations have been accepted and discussions are now focusing in the NEG or National Energy Guarantee. The NEG focuses on a prescribed level of emissions (Emissions Guarantee) and a Reliability Guarantee. Notwithstanding the lack of detail, we provide the following commentary.

The Reliability Guarantee will only be triggered if the AEMO believe that there will be a shortfall in the reliability standard. The AEMO will provide three years notice of a potential shortfall, i.e. put the industry on notice that the “Procurer of Last Resort” power may be exercised. If the reliability concern still exists one year into the future, then the retailers will have to demonstrate that they hold sufficient financial contracts to avoid spot exposure during periods of peak demand. Penalties will be applied to retailers who do not hold sufficient contracts, but the real bite is that sites with a demand of more than 5MW may have to procure their own capacity.

The Emissions Guarantee is currently targeting a 26% reduction in emissions in 2030 when compared to 2005. However, the mechanism is sufficiently flexible to allow for this target to be adjusted. Unlike the current system which trades renewable energy certificates, retailers will have to demonstrate that the average intensity of electricity generated on their behalf is below the government's target.

This is the first major change to the NEM since its introduction almost 30 years ago and there is still much uncertainty vis-à-vis final detail and effectiveness. Given the current high prices and continuing ingress of intermittent renewable generators, some change is clearly required. However, it is hard to understand why the current mechanism of trading environmental certificates has been set aside. Similarly, it is hard to understand why we did not adopt a Capacity Market, as per WA and many other deregulated markets across the world.

So where are prices? The Electricity Futures Index (EFI) as shown below is probably the best guide to forward electricity prices. The only problem is that the EFI, which is derived from the cost of electricity futures as traded on the ASX, only covers the next few years. Hardly long enough to make an investment decision.

EFI

And what is our long-term estimate? Sometimes it is best to set aside all the complicated economic modelling and just use some common sense. Sure, the Short Run Marginal Cost (SRMC) of PV or wind is close to zero, but capital must be recouped so it is fair to say that these plants will need upwards of $65/MWh including RETs. Gas has a SRMC of about $80/MWh, but again there is a need to recoup capital cost. Put it all together and you might get a black energy price of somewhere between $65 and $85/MWh depending on generator mix.

Environmental Levies are the big elephant in the room. The Commonwealth Government’s Mandatory Renewable Energy Target (MRET) is probably adding $20/MWh to the cost of electricity. This underpins many of the wind farm and large solar developments, but as the supply of renewable generators increases, the value of these certificates plummets and compliance cost will decrease. That does not mean, however, that delivered energy costs will decrease. Renewable energy developers may just increase the cost of their black energy so that they can recoup any losses made by falling certificate prices.

KE&R hold AFSL No 281356. Any advice contained herein is general in nature and not specific to any client's requirements. Further personal advice should be sought from a qualified consultant before making any decisions relating to material contained herein.

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