A country as resource-rich as Australia shouldn’t suffer from rising energy prices but it does and the reasons frustrate investors and consumers alike.
Australia’s energy market has been hamstrung by shambolic policy decisions for decades, highlighting some surprisingly archaic attitudes that are holding back one of the Asia-Pacific region’s most developed economies and making it virtually impossible for institutional investors to gain access to the renewables sector.
The result is a worrying surge in electricity prices. Household power bills have increased by 20% annually since 2015, while industrial users such as manufacturers and food producers that aren’t subsidised are paying even more, with their bills up 60% since the middle of last year.
The cause is a spike in the cost of gas, a key source of peaking power. The price gas-fired power stations pay for their fuel has increased from a long-term average of A$3 per gigajoule to as high as A$20 per gigajoule, while overseas buyers of Australian gas still pay in the low single digits.
Such a scenario is hard to imagine in a country so abundant in natural resources. Australia has grown rich by selling fossil fuels to the rest of the world but it now transpires that the domestic market is being starved of natural gas in favour of fulfilling export contracts.
In fact so much Australian liquefied natural gas has flooded into the international market from three massive new plants near Gladstone in Queensland that a global LNG glut has set in. Yet, local businesses and consumers are experiencing shortages.
In June Prime Minister Malcolm Turnbull took drastic action to correct the distorted market by imposing export restrictions. Gas producers will be required to boost supply for domestic users before they are allowed to send it offshore.
The move has been welcomed by energy users but criticised by those who worry that knee-jerk policy decisions create uncertainty and amplify Australia’s sovereign risk.
“Investors are trying to operate in a market where there has been no clarity and a lot of rule changes. It is a shambles,” Tim Buckley, a director at the Institute for Energy Economics and Financial Analysis (IEEFA) in Sydney, said.
“The policy vacuum is severely hampering domestic innovation in new sources of renewable energy,” Buckley told FinanceAsia, urging the government to act quickly and decisively to stave off an energy crisis.
According to Bloomberg New Energy Finance, Australia spent A$4.3 billion on solar and wind farms in 2016, up 50% on the prior year. That is below the amount needed to reach the country’s current green generation target of 20% by 2020 and places Australia ninth globally for clean energy investment.
Projects like pumped hydro storage – which could form the mainstay of a 100% stabilised renewable energy system and be cheaper than new coal or gas plants, according to an Australian National University study – remain on the drawing board, unable to attract financial backers.
Spencer Ng, an analyst at Moody’s in Sydney, said government indecision spooks capital market players and also leaves them out in the cold. “Renewable projects are usually funded through the bank and project finance markets or on corporate balance sheets,” Ng said. “Regime uncertainty makes it more difficult for third-party investors to assess the value of renewable assets and the ability to recover their investments in the long run.”
There is plenty of local institutional investor appetite for sustainable projects. Australia has A$2.3 trillion in retirement savings held in superannuation funds and the focus on green investments is increasing.
One such fund is Local Government Super (LGS), which manages A$10 billion on behalf of local government employees. Nearly 10% of the fund is invested in assets with a climate change theme, including A$110 million in energy infrastructure.
Most of that is invested overseas, Bill Hartnett, head of sustainability at LGS, said.
“Up until recently we haven’t been able to reach a point of comfort around cash flows on local renewables projects,” Hartnett said in an interview with FinanceAsia. “We want assets with steady yields and low capital variation, and we find this more readily in markets like Asia and Africa.”
LGS’s largest allocation to renewable energy is to London-based Actis, which owns wind and solar companies in Africa and Latin America.
Three months ago the fund finally made an allocation to a local outfit, giving A$40 million to Lighthouse Infrastructure for the construction of two solar farms in remote areas of Australia “We probably looked at 100 local opportunities before we settled on Lighthouse,” Hartnett said. “The policy risk around renewables is high and the market has been thwarted by random decisions. The industry desperately needs clearer direction.”
Good policy needed
The government isn’t deaf to such appeals and in October last year commissioned its chief scientist Alan Finkel to prepare a roadmap for energy security. His final report was released in June this year and proposes a range of market and regulatory reforms.
Finkel worked carefully around the current pro-fossil fuel political climate and steered away from recommending measures like a carbon price on emissions or a comprehensive emissions trading scheme. Instead, he proposed a Clean Energy Target (CET) to increase Australia’s renewable energy use to 42% of total energy use by 2030. The system would allow electricity retailers to accrue certificates to demonstrate they were buying a certain quota of power from low-emission generators.
“This was a watered-down version of the carbon price we wanted but it was still better than a business-as-usual scenario,” LGS’s Hartnett said.
Independent consultants Jacobs Group predicted that both wholesale and retail prices would fall under the CET and that coal power stations would be phased out as more capital was invested in new low-emission generators to help meet the target.
But the conservative government has baulked at the idea, deciding in late June to approve just 49 of Finkel’s 50 recommendations and rejecting the CET proposal pending further debate.
“I am astounded at the short-sightedness of this Federal government,” said Buckley at IEEFA, echoing the frustrations of many in the investment community. “We need rapid deployment of capital and this decision is a huge blow to investor confidence.”
Finkel devised the CET to replace an existing mechanism known as the renewable energy target (RET), which runs out in 2020. The goal was to build 32,000 gigawatt hours of new generation and so far about half of that capacity has been constructed or reached financial close.
“There will be a period of intense deal-making between now and 2018, and construction out to 2020, but after that things will taper off and eventually come to a standstill unless another mechanism is put in place,” Darren Gladman, director of smart energy at the Clean Energy Council, said.
“The longer the policy vacuum continues, the less likely we will have substantial new investment in generation and the greater the chance that prices will spike again.”
Price spikes can occur when old power plants close down and there isn’t enough capacity to take up the slack. This happened in March 2017 when the 1,600-megawatt Hazelwood coal-fired plant in Victoria’s La Trobe valley closed after nearly 50 years in operation.
Australia still generates close to 80% of its power from coal and more than half of the generation assets are beyond their expected lifespan. The next big closure is likely to be the Liddell plant in New South Wales. Commissioned in the early-1970s, it is bigger than Hazelwood at 2,000 megawatts.
“Taking this amount of generation out of the system has a significant impact on supply,” Gladman said. “If we haven’t built enough reliable generation by the time Liddell closes, the demand/supply imbalance will push up wholesale prices.”
Investors say the CET is critical to giving energy buyers the confidence to sign power purchasing agreements (PPA) with new and existing renewable generators. Such agreements are the cornerstone of good investments, said Hartnett. “A long-term PPA with a solid credit-worthy counterparty offers certainty around cash flows.”
The only electricity buyers willing to sign long-term PPAs are the state governments. The Australian Capital Territory has a 20-year purchasing agreement with two wind farms in Hornsdale and the South Australian government has a 20-year offtake with Coober Pedy wind farm.
Private buyers of power such as the electricity utilities are more reluctant to commit to long-term PPAs.
Gladman explains the problem. “Most commercial customers are on two-year contracts, so retailers will tell you it is difficult to sign PPAs for their entire RET liability against all customers,” he said.
Another impediment is the speed with which technology is advancing in the renewables space. “The cost of producing renewable energy is dropping almost daily. Buyers don’t want to be locked into [a] technology that might [soon] be out of date.”
Ng at Moody’s admits that shorter PPAs are less risky from a credit perspective. “We would be worried if companies were locking themselves into long-term contracts when costs are constantly falling.”
Without a clean energy target, however, there is a risk that contracts won’t be signed at all.
Ideology equals poor investments
At the heart of Australia’s shambolic energy policy is ideology. There is a belief among conservative politicians that fossil fuels form the backbone of the local economy and if they don’t support the country’s mining companies they are being disloyal and negligent.
Climate-change sceptics within the government claim renewables are expensive to build and require excessive subsidies to make them viable. They blame inefficient wind and solar farms for pumping up electricity prices, despite a weight of independent analysis pointing to higher gas prices as the cause.
The ideology runs so deep that during the debate that followed the release of the Finkel report one government member flagged the idea of using public funds to build a new coal-fired power station – an investment the private sector has long since discarded as not being viable.
Buckley at IEEFA said such “pro-fossil fuel madness” has led to a number of poor investment decisions such as the LNG plants recently opened near Gladstone in Queensland. The three plants owned by Shell, Santos, Origin Energy, and Conoco Philips came online from late 2014 to 2016 with contracts to supply Asia with gas.
The liquefaction and shipping facilities turned Australia into the world’s biggest LNG exporter, but it also had the unintended consequence of creating gas shortages at home.
“These multinational investors in Gladstone LNG have overspent by 30% and now we have A$70 billion of stranded assets up north,” Buckley said. “They built too many facilities too quickly and locked themselves into lengthy offtake agreements which have taken far too much gas away from the domestic market. The government is probably only making a fraction of the royalties it expected to get when it approved these enormous projects.”
Since the Gladstone plants are among the highest-cost producers they will be the first to cut production if the global LNG glut continues.
For LGS’s Hartnett, Australia needs to move quickly to stimulate investment in market-based, policy-neutral projects.
“We need peaking capacity and with gas priced out of the market this has to come from battery storage or pumped hydro,” he said.
In early July the South Australian government announced the construction of a 129 megawatt-hour lithium-ion battery, the world’s largest by capacity. The battery’s output will be integrated with, and will supplement, generation from the 315 megawatt Hornsdale wind farm.
Buckley said the country needs many more projects like that to secure future energy supplies.
“The real crime of policy indecision is that we are missing a massive opportunity to be a world centre for emerging energy technologies,” he said.
The IEEFA estimates that there are 9.2 million people employed in the low-emissions technology sector globally and that most of these are in China and India. Australia should be at the forefront of this development instead of sinking billions of dollars into projects like the LNG plants in Gladstone.
Businesses buckle under higher power prices
Elevated electricity prices have increased the cost of doing business in Australia and could push companies and jobs offshore.
Corporate users pay a rate equal to the wholesale price for their power and this has increased from an average of A$60 per megawatt hour in mid-2016 to nearly A$100 in the early part of 2017.
Businesses with high-energy needs such as manufacturers and food producers are particularly hard hit, Shane Oliver, chief economist at AMP Capital in Sydney, said.
“Low-cost energy was a competitive advantage for our manufacturing industries and this advantage has been completely eroded,” Oliver told FinanceAsia in an interview. “A typical food processor or manufacturer relies heavily on energy to keep production lines going.”
So far companies have been coping by cutting costs in other parts of their businesses but there is a limit to how much can be trimmed.
“The next step is to become more energy efficient and then it is about passing increased costs on to customers, if their market position allows it,” said Spencer Ng, an analyst at ratings agency Moody’s.
Larger corporations have an advantage over smaller companies due to their purchasing power, Ng said. “Companies that use a lot of power can negotiate on price and tenor but smaller users may not have that option.”
Oliver believes companies can withstand another two years of elevated power prices before they begin to lay off workers and relocate their operations overseas.
“A lot of the damage has already been done and sadly this situation could have been avoided,” Oliver said. “If we can get electricity supply up and prices down within the next year or so we might be able to minimise job losses and stem the flow of companies offshore.”
