Many clients coming up to renew their electricity procurement contracts are asking us why the prices that they are now seeing are so much more expensive than those under their current contract?
A glance at the Energy Action Price Index shows us that since mid 2014 the price for electricity excluding network charges, renewable certificate costs and other non-energy related items has gone up in every state. The reasons behind this general trend are covered in Energy Action’s commentary piece “Why is my new electricity contract costing me more?” which you can find under the news section on our web site. However, for South Australia the increase has been much greater than in any other state, and nearly all of it has come about in the last nine months. This article looks at the reasons for this sudden and very large increase in South Australian prices and helps to explain what’s behind it.
The first thing to note here is that between mid 2013 and mid 2015 prices in South Australia weren’t that much different than for the other states. During this period they were pretty much following the same trajectory as the rest of the market, but at a much higher level than for NSW or Victoria.
South Australia being the highest priced state is nothing new, its pretty much been like that for a long time. Part of the reason goes back to the types of power plant that were built there before the market opened up in the mid 1990’s, and what new plant has come along since.
Unlike Victoria, where prices have always been amongst the cheapest in the interconnected states, South Australia didn’t build much coal fired generation. Instead it built gas fired power stations, partly because the coal deposits that it does have aren’t in the most convenient locations. Since the market was de-regulated in the mid 1990’s the new fossil plant that has been built in South Australia has all been gas fired. Add to that the fact that the electrical interconnector to Victoria is relatively small which limits the amount of cheaper power that can be imported, and this explains much of why South Australia has always been so dear. When we look at what has happened over the last nine months, it also partly explains why prices have recently increased so dramatically.
By mid 2015 there were only two coal fired power stations in the state, Playford B and the Northern power station in Port Augusta. In June of that year Alinta announced that both stations would close some time before March 2018 at the latest. As Playford B had by then been mothballed for several years the announcement only really affected the 520MW Northern station.
Whilst this looked worrisome for prices, there were other things that looked like they would help. For several years ElectraNet had been speaking of increasing the transfer capability on the Victoria-South Australia interconnector, and by mid 2015 this had been given the go ahead for a June 2016 completion. That upgrade was to increase the maximum import from Victoria by 190MW. That’s less than half the capacity lost at Northern, but it’s still a sizeable chunk. With the upgrade expected to be in by about now, and with no fixed date for Northern’s closure, things didn’t appear to be too bad.
However, two things then happened. The first was that In October of last year Alinta announced that Northern would close by the end of March this year, much sooner than anyone had anticipated. Shortly after that announcement the price started to increase, but at the time it looked like this might just be caused by worries that an excessively high temperatures could push up demand and therefore prices in the forthcoming summer. The second thing was that that the timing on the interconnector upgrade started to slip and in February of this year AEMO put out a little observed notice saying that the increase in transfer capability would not reach its full 190MW until March 2017, nine months later than expected. Fast forward to today, and we now have a large chunk of generation in the form of Northern that is out of the market permanently, and a much slower introduction of the upgraded interconnector. Sounds like a recipe for higher prices, but is that still enough to explain such a dramatic increase?
Withdrawal of the Northern station may be producing another impact. The electricity retailers buy their physical electricity through the spot market operated by AEMO. In that market the price can and does fluctuate wildly. In South Australia over the last 12 months the average spot price for a single day has varied from 26c/kWh to -0.6c/kWh (yes, minus 0.6c/kWh, although it was only negative for one day). Faced with that kind of volatility retailing would be an extremely risky business, so to mitigate this risk the retailers also buy hedge contracts to protect themselves against high priced outcomes. How these hedges work is too complicated to go into here, but suffice to say that they effectively fix the price that the retailer pays for his electricity at a level agreed before the contract starts, so eliminating the spot price volatility. The majority of electricity sold by retailers will be covered by these hedges. So if retailers are the natural purchasers of hedge contracts, who are the natural vendors? The generators of course, and they provide the majority of hedge cover purchased by the market. All of which brings us back to Northern, and the interconnector upgrade.
With Northern out of the market a sizeable source of hedge cover is no longer available, which increases the risk on the retailers and encourages them to lift their prices as a result. But wait, can’t the retailers buy at least some of the missing hedges from the increased interconnector? Well, not very easily as it happens. The electricity that flows through the interconnector is produced by generators located in Victoria. But because they are in a different region (i.e. not in South Australia) they can’t easily write a hedge contract for electricity to be consumed in South Australia. That would be similar to an Australian manufacturer of milk products agreeing to sell cheese for delivery over the next twelve months at a fixed price denominated in roubles with no idea of how many Australian dollars that would translate into by the time payment was made. The difference is that whilst foreign exchange rates are only highly volatile, electricity spot prices are incredibly volatile. So the result is a shortage of hedge contracts. And that’s likely what is really behind the high retail prices that we are seeing today.
However, some relief may be at hand. In late 2014 AGL announced that it would be closing its 480MW Torrens Island A plant in 2017. That has been known about for a long time. However, in the first week of June AGL issued statement a saying that it would not now be closing that plant after all, the reason being high prices and the risk of supply interruptions if the amount of generation capacity fell any further (see link to AGL media release below). So, Northern out, Torrens Island A back in, with a gap of about a year between the two, and we are back pretty close to where we started. If the future is in any way like the past, AGL’s announcement should start to bring the price of retail contracts back down, although how long this will take and to what level no-one can say.
The question that everybody customer asks of course, is what do you do about it? For that, contact Energy Action. With more than ten years experience in electricity procurement and as the largest independent provider of energy procurement services in Australia we’d be delighted to help you.
Read more: AGL to defer mothballing of South Australian generating units.