04/03/2014 - 11:20

State review to consider sweeping electricity reforms

04/03/2014 - 11:20

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SPECIAL REPORT: Energy Minister Mike Nahan has told Business News a review of Western Australia’s wholesale electricity market could open the door to some dramatic shakeups in the sector.

State review to consider sweeping electricity reforms
Mike Nahan says the review of the wholesale electricity market will look at previously unconsidered options. Photo: Attila Csaszar.

Energy Minister Mike Nahan has told Business News a review of Western Australia’s wholesale electricity market could open the door to some dramatic shakeups in the sector.

In an interview ahead of the March 6 announcement of an upcoming review of WA’s electricity market, Mr Nahan confirmed previously unconsidered items would be on the table for discussion.

“Disaggregation (of Western Power) took place seven, eight years ago. It’s time for a review. It had clear flaws, both from the government’s mandate and how it’s been implemented. We will look at those flaws,” he said.

“Its main aim was to get the private sector to compete with the government. That’s failed. It promised to have the state reduce its subsidy (but) it has increased substantially.

“Our subsidy has gone from almost zero in 2006 to $500 million and that’s despite an increase in electricity prices by nearly 80 per cent. So there are some flaws in the market.”

Mr Nahan said the government was working on three main objectives.

“How to keep electricity prices low; second, how do we reduce our subsidy, and third, how to get the private sector to build, own and operate and take the risk of generating,” he said.

Mr Nahan told Business News the government would now consider a number of major changes, including fundamentally changing the way payments to generators were made, moving to a system more in line with that used on the east coast.

WA’s electricity market is much smaller, more isolated and more volatile than that on the east coast, where an integrated network connects every power user and generator from Queensland through to Tasmania and across to South Australia.

Because WA’s electricity market and network grid is much smaller it has certain inbuilt safeguards, which until now have been off limits to change.

In this state, the government ensures supply by paying for a two-part insurance scheme, which supplements the energy market in which generators supply electricity and retailers sell it.

This includes paying generators to retain spare capacity (known as the capacity market) and paying large electricity users to reduce power during peak times (known as demand side management).

Elsewhere, including the east coast’s National Electricity Market, an energy-only market model is used, where generators must earn their entire revenue through selling to the market or by signing bilateral agreements with retailers.

Mr Nahan said the state would consider stripping WA of its capacity market security blanket, because since the disaggregation of Western Power in 2006 the market had built up surplus supply, at a great cost.

“There’s a whole bunch of people building ‘peakers’ that never will turn on, and they’re doing that not to sell electricity, but because they get the capacity payment. It’s money for jam and we’ve been doing this for five years,” he said.

When Western Power was split into four entities – generator Verve, retailer Synergy, network operator Western Power and regional supplier Horizon Power – it was primarily to pave the way for greater competition.

A number of issues have arisen, however, which Mr Nahan said the review of the electricity market would examine.

Retail competition

One of the major changes the review will consider is whether to open the state’s residential market to full retail competition.

In WA, only businesses of a certain size (and power usage) are considered contestable, allowing them to buy their electricity from retailers other than Synergy, including Perth Energy, Alinta and Griffin.

While residential customers on the east coast can choose from a number of electricity retailers, Premier Colin Barnett has previously said he believed WA’s market was too small, leading him to maintain that competition should exist for larger electricity users only.

Now, however, Mr Nahan said the government was interested in looking at full retail contestability, despite the likelihood such change would be several years away if recommended in the review.

“That’s a long way down the track because as long as we’re subsidising electricity to consumers to $500 million a year, we’re not going to go to full cost recovery,” he said.

Mr Nahan said the state wanted to fix the mistakes that had come out of the 2006 electricity market reform.

“One of the issues of the reform was it did not lead to the private sector coming in and taking market risk,” he said.

“If the state government underwrites all generation, which it has, that’s not a competitive market.”

Mr Nahan said while the private sector had invested in new generators, Synergy had signed contracts with the generators to buy their power at a fixed price, effectively lumping Synergy with all the risk.

“Losses are borne by Synergy, not by the private sector, and that is why we’re losing so much money,” he said.

Mr Nahan said the review would look at how to deal with a market that on average used 1,300-megawatt hours per day but had the capacity to cater for 6,086MW.

One reason for the significant excess capacity in the market is because the system is designed to meet a very conservative one in 10-year peak load event, a demand that has never been reached.

“Right now we have gross excess capacity in the market … it’s costly as hell. We’ve encouraged far too much capacity into the market when it hasn’t been needed for years,” Mr Nahan said.

“In the hot months so far in January we had a week or so of 40 (degrees and) we were only using 35 to 40 per cent of our generating capacity.”

State of the market

While problems with the current market arrangements are widely known, there is a lack of consensus on a preferred way forward.

Consultant Steve Gould, like many familiar with the wholesale electricity market, believes the market is, overall, healthy and effective.

“It’s a hidden jewel,” Mr Gould said.

“Very few people appreciate we’ve got it.”

Mr Gould, who is the principal of retailer Community Electricity and the former general manager of retail at Landfill Gas and Power, said his business worked by passing through the wholesale costs of electricity to customers plus a service fee.

“This contrasts with most retail models, which involve guaranteeing a price, taking the risk that the cost of supply will be lower, and keeping the difference,” he said.

Mr Gould said this unique operation method only became possible because changes to the market had delivered economically efficient energy prices.

“In effect, it became possible to offer customers pass-through of wholesale electricity prices with a high expectation that they would be stable and low,” Mr Gould said.

Despite his belief in the overall functionality of the electricity market, Mr Gould and others agree there are some glaring problems.

The big issue is the amount of excess capacity that is being paid for, but rarely used.

Economic Regulation Authority chairman Lyndon Rowe said the price generators received for providing capacity was too high, and this had encouraged excess capacity.

“There are a number of 10MW diesel units out there that in our view will never be turned on, other than to trial them,” he said.

“They get paid the capacity payments and the capacity payment is enough to make them worth having, so there’s an issue over the capacity price in my view. The capacity price has been too high.”

In addition to the capacity market, the significant growth of demand-side management has contributed to an excess of capacity.

“Demand-side management can be useful, no question about that, but … if you’ve got excess capacity, they’re never going to be called on,” Mr Rowe said.

Private investment

How much energy will be needed in the future has pundits divided.

Mr Nahan said investment in new generators would not be needed until after 2020.

“We don’t need any peaking plants for a while. We have plenty of peaking plant, we have plenty of base load, we have mid merit, but the real issue is when do we need more investment?” Mr Nahan said.

“Probably the experts tell me in 2020 and beyond. And by that time we will be looking for the private sector not only to build that plant, but to take the market risk. The state is going to get out of guaranteeing private sector investment. We’re not going to do that anymore.”

While Mr Nahan criticises the growth in excess capacity, it was his predecessor Peter Collier who in 2009 announced that the government would refurbish Verve’s 850MW Muja power station to boost capacity.

Muja is still not fully ready and costs to secure generation have now blown out to $336 million, from an initial estimate of $100 million amid assurances no taxpayer money would be used.

Electricity retailer Perth Energy’s managing director Ky Cao disagrees that new investment won’t be needed for a while.

Mr Cao echoed Mr Gould’s statements that the energy market was sound, but said that didn’t mean it was perfect.

“Market participants have in the last couple of years been urging and expecting the government to review the wholesale electricity market to improve it after seven years of operation,” Mr Cao said.

He said despite an overcapacity of electricity being seemingly available, some of this capacity was too unreliable to be counted on.

“On paper there is an overcapacity but in reality there isn’t. The excess capacity is taken up by demand side management and very old power stations that are given capacity credits with very, very low reliability benchmarks,” Mr Cao told Business News.

“We’ve got generators with capacity availability of 40-50 per cent and still receiving full payment. So they are counted as capacity in the system but they are not really reliable when a crisis hits in terms of demand peak.”

Mr Nahan said the state had been admonished for poor availability levels of some of Verve’s generators and new thresholds had since been introduced to reduce allowable outage rates.

“(The ERA) highlighted the issue of some of (Verve’s) kit being off for long periods of time,” he said.

“What happened was Verve kit of a certain age went through a major overhaul of the systems and (was) off for long periods of time, because with excess capacity there wasn’t any demand to turn on, so you might as well repair the thing intensely over a period of time rather than turn it on and shutting it off.”

Mr Cao said available capacity from demand side management was also questionable, and had lulled people into a false sense of security and discouraged new investment.

“The other half of the excess capacity is demand-side management, having a commercial contract saying when demand peaks in summer we will shut down for payment; but that’s a commercial arrangement, it’s not mandatory,” he said.

“So what if those 400-500MW refused to shut down during a demand peak? They get some sort of commercial penalty and nothing else.

“Of the 800-900MW of excess in system, half of it is just power stations that are not reliable and the other half is just demand side management that is outside the bidding system anyway. If there is a crisis in terms of heat wave, I think our system will be stretched.

“Everybody is pulling back and there is a misperception that that’s ok because you have so much excess capacity, but the reality is we don’t. Someone has to make a decision about investing in new peaking power stations next year because in 2017 we will need more peaking power stations.”

Mr Gould said answering the question about whether WA had a genuine electricity oversupply was complicated.

“It depends on what perspective you take, broadly speaking Ky (Cao) is pretty right I think. Part of the issue that we have at the moment is we have a lot of pseudo capacity in the market called demand-side management,” Mr Gould said.

“It’s an intellectual argument. This summer has demonstrated that we have ample energy producing plant, so base load and mid merit. But the question is though, it takes three years to build a power station, so what’s the outlook?”

The state plans to retire Kwinana C, one of its biggest generators with 360MW capacity, in about a year.

“When that plant goes arguably things could get tight on energy,” Mr Gould said.

He said one of the biggest problems facing the electricity market was the likely potential for network operator Western Power to significantly raise costs.

Currently up to 40 per cent of the costs consumers pay for electricity is due to Western Power’s network charges.

 “This is a potentially considerable long-term threat to electricity tariffs that could dwarf any other concern,” Mr Gould said.

Price signal response

Industry funded Independent Market Operator chief executive Allan Dawson said WA electricity users had been responding to price increases by reducing demand much more than experts predicted.

Mr Dawson said a recent very hot day, which was expected to put stress on the system, passed without alarm partly because a group of large electricity users anticipated a rise in price and pulled back on their electricity usage.

“This last summer we didn’t hit a peak, even though we had a very, very hot day and I asked my guys why we did that,” he said.

“When they did some exploration they suddenly discovered that these guys, these 59 big loads, are starting to respond really quite significantly to those peak periods.”

Mr Dawson said the reduction in electricity usage was significant, with large businesses that typically consumed 110MW per hour, dropping to as low as 40MW per hour, meaning they were shutting down operations.

“So if you allocate costs to these guys, they respond. No one’s asking them to do this, this is purely voluntary,” Mr Dawson said.

“Last summer their response was approximately 65MW, the summer before it was 50MW and then in the summer before that it was 15MW, so it’s growing and there are more of them that are starting to respond.

“The knowledge and understanding of the cost drivers in the wholesale electricity market is certainly starting to be understood.”

Mr Dawson said in the past few years large businesses had become serious about reducing their electricity usage and educating themselves on how the market worked, to facilitate cost savings.

“In boom times no-one really worried about costs, now people worry about costs,” he said.

“If I’d have conducted that large user forum four years ago I wouldn’t have got very many people at it, but the fact that I got over 100 people and the year before it booked out a month in advance (shows) the interest from major users, contestable customers, is high.”

Synergy merger

In 2011, when Mr Barnett suggested the re-merger of Synergy and Verve, before announcing last year that it would go ahead, the proposal was greeted with distain.

It was publicly criticised by players in the electricity industry, including the ERA and Perth Energy, as well as industry groups including the Chamber of Commerce and Industry WA and the Chamber of Minerals and Energy of Western Australia.

While Mr Rowe said the ERA remained opposed to the merger, he was pleased with the groundwork that had since been done to facilitate it.

However, he said the merger now required the ERA to monitor ring-fencing arrangements between Synergy’s remerged generation and retail arms.

“It becomes more difficult, clearly, when you’ve got one organisation, from when you’ve got two. We’ve had experience in regulating the ring-fencing arrangements for the South West railway line. It was more tricky when the owners of the above rail and the below rail were the same. Just naturally it’s harder,” Mr Rowe said.

Mr Cao said the ring-fencing arrangements were absurd.

“This raises a fundamental inconsistency. First, why merge them and then impose on them a contortionist ring-fencing arrangement to protect commercially sensitive information in dealings with third parties?” he said.

“Second, the new Synergy has shared services between its generation and retail arms, such as billing, HR and corporate strategy. If this is the case then executive management and the board are being expected to play dumb, deaf and mute with themselves since they have access to all information for both generation and retail, regardless of ring-fencing. 

“How can the government expect them to be neutral to external parties without putting their own performance at risk?”

Mr Nahan said that, in addition to reducing duplication and stopping the two entities from competing with each other, the merger would help facilitate the state selling some of its generators to private investors, which would increase competition.

“What it will do is it will finally get the low price Verve kit into the private sector hands to compete with the retail section. So that opens it up to competition quite strongly. The merger is just one of the steps. It’s not the biggest issue, it is an important one,” he said.

Mr Nahan said privatising more assets was key, but he did not have a target for how much of the market the merged Synergy entity could turn over to private investment.

“We’re not going to sell Synergy and Verve but we will sell some assets that obviously will go into private hands,” Mr Nahan said.

“We’ve made it clear Muja A and B will be put on the market when its up and operating. We might put some other things on there (later).

“Given the current situation in the market I don’t think the assets are that valuable because of excess capacity, but we don’t know.

“I want the market to drive the optimal investment. I don’t know, that’s one reason we’re undertaking the review.”

Labor energy spokesman Bill Johnston said he was pleased the government had finally called a review, which the opposition had asked for in February last year.

He said in six years the government had not implemented any reforms, and despite carrying out a strategic energy initiative in 2011 aimed at planning for WA’s energy future, it had not implemented any recommendations.

“Is that what’s going to happen again here? Are they just going to look at it or do something about it,” Mr Johnston said.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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