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Select Committee on Electricity Prices
Electricity price increases in Australia

SWIFT, Mr David Gordon, Acting Chief Executive Officer, Australian Energy Market Operator


CHAIR: Welcome, Mr Swift. Do you have an opening statement you wish to make?

Mr Swift : Yes, I do. Firstly, thank you for the opportunity to appear before the committee today. We welcome the opportunity to provide input into your work. AEMO's submission to the committee focuses on some of the drivers of electricity price increases, network investments and the changing nature of demand.

AEMO, the Australian Energy Market Operator, is an independent, not-for-profit organisation that operates the energy markets and energy systems. It also delivers planning advice in eastern and south-eastern Australia. I would note to the committee that, despite our name, we do not have responsibilities in Western Australia or the Northern Territory.

AEMO has two core operational roles with respect to the electricity market in eastern and southern Australia. First, we are the power system operator and market operator, and these system and market operation functions are largely integrated into complex systems to dispatch all generation in this part of Australia.

AEMO also has a range of planning roles across both electricity and gas markets. In Victoria we have an additional role: we are responsible for planning and procuring new transmission capacity and for connecting generators and customers to the electricity transmission network. In this role, we plan using an economic cost-benefit test and we procure assets using competitive tendering arrangements. We also provide generators with choice over who builds their assets—something that is unique in the NEM.

Across all participating jurisdictions, AEMO holds the national transmission planner function. This role provides valuable information to stakeholders to facilitate the long-term development of an efficient national electricity network; however, this role is limited in that it is only an advisory role, and we cannot direct investment in the national grid nor prevent non-economic investments from proceeding.

In June 2012, AEMO published the first independent national electricity forecasting report which shows that the forecast annual energy sales will decrease, while maximum demand growth will continue to increase but at a slower rate than in previous industry forecasts.

This changed outlook for electricity consumption in the NEM represents a major change for the industry. The last few years have in fact been unique in showing declining electricity sales, despite continuing economic growth. Changes have been influenced by a slower outlook for growth, reduced consumption by manufacturing and mineral processing sectors in response to the high Australian dollar and international conditions, significant penetration of rooftop solar photovoltaic systems and changed consumer behaviour.

To date the NEM has conveyed efficient pricing signals and delivered the necessary investment in the right place at the right time. In real terms, the wholesale prices for electricity have not increased over the life of the NEM. The competitive generation market has also responded very quickly to the changed outlook; however, regulated investment has not.

The growth in capital expenditure over the past five years in networks has therefore outstripped the growth in both energy and peak demand and contributed to those rises in retail prices. While some of that expenditure has been necessary to deal with ageing assets, it is not clear that all the expenditure is supported by either the age of the network assets or the growth in demand.

AEMO believes that market and regulatory arrangements must be capable of responding to these changes and must deliver appropriate price signals to enable efficient investment. While the current NEM design primarily caters for the supply side of the market, it is generally recognised that it has not yet delivered optimal demand side participation. In an efficient, well-functioning market, customers would be able to respond to price signals and shift or curtail their consumption during high-price periods, such as through the use of flexible pricing plans, as was announced by Victoria yesterday. An enhanced metering framework which allows for improved integration of demand side in the wholesale market could also reduce network businesses' capital expenditure programs and place downward pressure on electricity prices.

CHAIR: Thank you, Mr Swift. I just want to ask you some questions about a report that was prepared for the AEMC by Parsons Brinckerhoff on 16 August 2012. Are you familiar with that report?

Mr Swift : No.

CHAIR: Okay. I will put these questions to you, and perhaps you can take them on notice.

Mr Swift : Certainly.

CHAIR: That report basically reported on the drivers behind capital overinvestment in terms of network service providers in the National Electricity Market. There were a number of case studies undertaken, but on page 12 they do a case study on Ausgrid covering the period from 2004 to 2009. It says:

It shows that, overall, Ausgrid overspent on Capex by approximately $925m (31%) compared to the benchmark expenditures set by the Regulator.

The simple question is: how do they get away with that, and what can we do to stop that?

Mr Swift : That is part of that study of those new regulatory arrangements that Mr Reeves was speaking about, and there are proposals in those new regulatory arrangements to require that, if someone overspends the total amount that they are allowed in their regulatory reset, they would have all their spending subject to after-the-event scrutiny. The current rules do not have any after-the-event scrutiny. The current rules require the regulator to take the regulated asset base at the end of one period as the start of the next.

CHAIR: So you are confident that the rule change proposed will deal with those issues?

Mr Swift : I believe that the rule change certainly would address that particular issue of people overspending the allowance, because that would obviously be a risk that that investor would then face—that they might not actually recover that money.

Senator EDWARDS: So you are a toothless tiger right now. You cannot—

Mr Swift : At the moment we do not have a role in that.

Senator EDWARDS: No.

CHAIR: In terms of demand reduction activities, some have expressed a view in some of the submissions that demand reduction activities might result in higher electricity prices in those jurisdictions where they have revenue caps. Do you have a comment to make on that?

Mr Swift : That would then be talking about retail regulation and how efficient retail regulation would be. We support competition where that can be effective, and obviously, if you start to try to have more innovative tariffs and arrangements which are trying to assist customers to respond to price signals, you would need to allow that competition to work and to flow through.

CHAIR: In terms of competition, I understand that it is the ACCC that determines whether or not there is sufficient competition in a particular market. What are the drivers that it uses to determine that? Are you aware of that?

Mr Swift : There have been a number of inquiries and considerations of the level of competition in the market. There are two aspects of that. One is that the ACCC have a role in monitoring competition within the broader industry, as they have done in all industries. They have from time to time taken action or considered action in our market. On the other side, though, there is the retail price competition or deregulation, and that has been set up through the ministers group as being studied by the AEMC, who do a review of each state from time to time and recommend whether there is sufficient competition to remove price regulation.

CHAIR: So at the moment there is only sufficient competition in Victoria.

Mr Swift : Not according to the AEMC, but other states at this stage have declined to deregulate.

Senator MILNE: I want to go to the point you made at the end of your presentation about most of the focus having been on the supply side and not nearly enough on the demand side. You noted that Victoria moved yesterday to go to time of use pricing. I want to address this whole issue of peak load and what the energy efficiency and renewable sector can do to shave off the peaks and what needs to happen. I am interested in your view and what you think. Is time of use pricing the most effective way? In addition to that, what would we need to see in terms of a recommendation or rule change that would require and facilitate actually taking energy efficiency and renewables into the system?

Mr Swift : I think there are probably a couple of points. We primarily work, of course, in the wholesale market and in the network regulation. What we see in South Australia would be amongst the world's worst in terms of the load factor—the peak load compared to the average—and Victoria is not much behind that. The reason for that is that we have a fairly mild Mediterranean climate, into which is thrown a few heat waves. In those heatwaves we use a lot of air conditioning, so we get a very high peak for a very short period of time.

In our wholesale market we set prices every half-hour. Medium and larger sized customers, or industrial customers, can see those price signals and they could choose to respond. If the price is getting up to a level where it is not worth their continuing to consume electricity they would not consume it, and that of course would be an efficient outcome.

At the smaller end of the scale, the cost and effort required to allow people to respond—having smart meters, as they are often called, or some form of interval metering—is quite high. At this stage Victoria is the only state in Australia that has mandated the rollout of those meters, although we are aware that there are a number of them in Australia for a whole range of reasons and the cost of the meters is dropping markedly against traditional style meters.

We would like to see arrangements put in place which allow voluntary take-up of those meters in the market or for customers or sectors who found it valuable to use the ones that are already there or to use products that include smart technology. That would then allow small business and residential customers to also respond to the price signals in a more efficient manner. There are a whole range of other things, though, in terms of energy efficiency. There has been some very good work done by the government in increasing the minimum efficiency standards for air conditioning, for example. All those sorts of things assist in reducing demand.

In terms of renewables, the big change in that area over the last few years has been the growth of solar photovoltaics. They do have an impact on peak demand. However, they do not entirely meet the peak because of timing. There is an issue for the late afternoon and early evening peaks. We have quite a complex pattern of consumption and there are a range of issues with trying to meet that most efficiently. The big cost is in the networks, in providing all that transmission and distribution down the street to meet those peaks for very short periods of the year.

Senator MILNE: The point is, surely, that if we facilitate bringing on the renewables and the energy efficiency you will be able to shave off the peak. It is already happening, isn't it, in bringing down the wholesale price of power? What I am interested in is the conundrum there, where the traditional suppliers, in coal particularly, are worried that if you bring on the renewables and efficiency and drive down the wholesale price of power it completely undermines their business model. So you have one side able to bring down the price but the traditional vested interest in the field not wanting the price to come down because it upsets their business model. How are you dealing with that conundrum?

Mr Swift : There was a range of assumptions in the way that you put that, but we operate an unbiased open market and all players, whether they are fossil fuel powered or renewable, compete in that market to supply. There are sometimes issues raised about some of the renewable generation, which gets a large range of subsidies outside of that market through things like the RET, but within the market there is total competition. I do not quite see why the argument goes there.

Senator MILNE: You are doing scenario planning for 100 per cent renewable energy.

Mr Swift : We are.

Senator MILNE: Can you confirm that the two scenarios you are modelling are 100 per cent by 2030 and 100 per cent by 2050? Can you tell me when we can expect that to be released and where we are up to on it.

Mr Swift : Sure. Yes; those are 100 per cent renewable, and that is for 2030 and 2050. They look at that year and say, 'What would the system look like in total in those years if we were meeting the demand in that year to the current level of reliability and security standards?' And, 'What would be the optimum mix of different renewable technologies and storage that would achieve that?'

I think it was last Friday that we released a range of information on what we are projecting all the costs are for all the different types of technologies—the range of technologies that we will be using—and the approach we will be taken to the modelling. That has been provided to the Department of Climate Change and Energy Efficiency and has been published. We are on target to complete the full project by March next year.

Senator MILNE: Will the community be given any opportunity to interrogate the assumptions behind the modelling before it is modelled?

Mr Swift : That is actually with the department. I believe they are consulting on those prices and input assumptions.

Senator MILNE: Does it include battery storage from a rollout of electric cars?

Mr Swift : Electric cars and several storage technologies are included in that suite of options; that is true. And they are very important, obviously.

Senator EDWARDS: Mr Swift, good morning. I want to take you to something you know quite a bit about: the South Australian scene, and our wonderful contribution to renewables in that state. It has been a state government policy, but unfortunately it appears that we are failing to be able to deliver the full benefit to South Australian consumers. Is it true that, given that we have a disproportionate amount of wind farms in South Australia, their capacity to recoup the cost of those wind farms across the National Electricity Market is causing the return to be recaptured from South Australians alone, because of the lack of the interconnector?

Mr Swift : The primary cost premium that is required out of running a wind farm or any other large renewable in our market over the cost of conventional fossil fuel generation is funded through the renewable energy certificates. That is by far the major impost of the additional cost of running renewable generation. In that sense, South Australians only pay for their share of the renewable energy. The rest of it is paid by all other Australians in meeting the agreed target.

So, on the first-order effects, South Australian customers probably do not suffer any detriment. As to whether there are any second-order effects caused by the volatility and so on, frankly it is impossible for us to say. When they generate large amounts, they often generate at very low prices or even negative prices. So I think it is hard to say that South Australians are disadvantaged by that. South Australians have always been disadvantaged by the mix of generation in South Australia, which is of a much lower scale than the other states. Having smaller generators puts you at a disadvantage, and South Australia does not have the same resources that are available in the eastern states.

On that, we have been jointly undertaking a study with ElectraNet, which was mentioned briefly by Mr Reeves. We recently published an analysis of that and we recommended that a $107 million project go ahead that would increase capacity both into and out of South Australia by about 40 per cent and deliver about $190 million in benefits.

Senator EDWARDS: Per annum?

Mr Swift : No, that is for the total project.

Senator EDWARDS: How do you quantify $190 million of net benefits for a $107.7 million spend?. Where does the $190 million come from? South Australians also suffer from, effectively, a cartel of operation there because they cannot get power from any other part of the grid efficiently either. So how is this going to deliver the $190 million and over what period? If you free up the market and let wind energy flow freely to the eastern states, which cannot happen now, and we cannot have the power coming in in periods of peak need to match what you called the world's worst environment for load factor, we have got a serious problem, haven't we?

Mr Swift : Yes.

Senator EDWARDS: It seems to me that $190 million is going to free up the market enormously. If you are going to spend $107.7 million, why don't you spend $150 million and increase it by 80 per cent? This would put South Australia on a level playing field like never before.

Mr Swift : Certainly. Plenty of people could put forward that there are advantages to one side of the market or the other by putting in a large interconnector. In this study we examined those kinds of options. Under the way the national market works, and for efficiency reasons, we choose the one which provides the largest net market benefit. So that $190 million is the net benefit after all the losses and costs. As soon as you go into a market and increase an interconnector, there are actually gains and losses all over the place with different generators and different customer groups. That is actually a net—

Senator EDWARDS: But what is the benefit to consumers? Where does the $190 million go?

Mr Swift : I would expect that $190 million to be reflected in lower prices for South Australian consumers.

Senator MILNE: Are you saying that wind would actually bring down the price of power in South Australia?

Mr Swift : The benefits there are both ways. The benefit would be for the wind farms to actually export more generation, so some of the benefits would go to South Australian wind farmers who would be able to export more. But there is also a 40 per cent increase in import capability. So, at times when the wind is not blowing, that would also improve competition into South Australia with eastern states energy flowing the other way.

Senator EDWARDS: Is it fair to say, then, that the policy was really at the wrong end, that they should have fixed up the capacity before they ramped up the load? Because it would appear that all Australians are paying for this unused renewable energy which is going to waste when the load is at its least.

Mr Swift : One could question how quickly some of these decisions are made and the timing of them. At the moment, we have done a study, obviously on what the situation is today. Studies had been done in the past and had not justified the expansion. The expansion of wind generation in South Australia has been quite astounding in terms of its speed. I would point out though, that customers do not bear the risk of them not generating—those generators do. That is the advantage of the competitive market and the private sector investment there; they have to generate to make a living.

Senator EDWARDS: They still guarantee a return on their investment, though?

Mr Swift : Yes.

CHAIR: The Clean Energy Council have said in their submission:

While embedded generation can play a pivotal role in reducing costs to consumers and carbon emissions, a key barrier to the further deployment of such technologies lies within the distributors.

They cite interpretation of the relevant legislation in favour of the distributor; no incentives for a distributor to process a connection application, rather it is a condition of their licence; and:

… the introduction of a generator into their network has the effect of reducing the distributor’s revenue from energy delivered, whist increasing the complexity and subsequent cost of their network assets.

Do you have a response to that?

Mr Swift : There have been a number of studies, and there is still work in train—we are doing work on trying to reduce barriers to entry to small generators. We would agree that there could be some improvement in the arrangements for small generators to enter the market. However, on the other side, you do need to recognise that distribution networks have traditionally been built as supplying customers, and it does require a change and investment to enable them to carry significant amounts of generation.

CHAIR: What improvements need to be made, in your view?

Mr Swift : I am not sure if this is the best time to go into all the technicalities, but one of the major issues with putting a generator inside a distribution network is what is referred to as 'fault levels'. A generator can produce a lot of current in a system and can cause failure of protection systems and switching systems. It is really just the manner in which they have evolved. There were not such things as distributor generation when much of our distribution systems were built, so they do have technical limitations. I am not saying that we should not improve the arrangements for connecting embedded generators—I think that we should and that we should look at ways to reduce the barriers—but there are some technical issues as well.

Senator THORP: This may or may not be in your area of expertise, but it has been suggested to me that one of the impacts of increased uptake of photovoltaic systems on domestic roofs is going to mean an increase in prices to more low-income earners, who do not have the capacity to make that kind of investment. Would you care to comment on that?

Mr Swift : That is a bit outside our area because it comes into the retail part of the market; but the argument has really been that the cost of providing the premium to customers who purchase those rooftop solars is fed back to all other customers.

Senator THORP: Given our terms of reference and your area of expertise, what do you think would be the single most significant recommendation this committee could make?

Mr Swift : We think that there are some changes required to the system to ensure that network investment better aligns with the actual needs of consumers. We look forward to some improvements in the regulatory regime, but we also think we could offer more in terms of our capability to plan and procure assets.

Senator MILNE: If you could just confirm this in relation to wind: my understanding of your review into wind particularly said that the NEM was well positioned to integrate large volumes of wind energy, contrary to claims that it would require backup generation and additional transmission capacity. That is pretty exciting, really. Can you just expand on that?

Mr Swift : As I said before, we are independent and unbiased and, fortunately, due to funding by the Commonwealth government, we have a state-of-the-art wind-forecasting system integrated within our market. We consider that the market design and the way in which it works is among the best in the world to integrate wind. We are currently integrating amounts of wind in South Australia which on any measure is either the highest relative penetration rate or certainly in the top three penetration rates in the world. We have not had any problems with security or reliability through that process, so we do consider that the market does integrate those in well, and we have not had any problems in a technical sense at all.

Senator MILNE: No technical problems that require more transmission or additional generation to back them up?

Mr Swift : We do not know exactly what changes and costs other generators have, but from our systems point of view we do not recruit any more what we call ancillary service generation.

CHAIR: Thank you, Mr Swift.

Proceedings suspended from 0 9:50 to 10:02