Lights out?

A discussion by Ian Hardy, Portfolio Manager of Private Portfolio Managers

Steve Sargent, a non-executive director of Origin Energy Ltd, and prior CEO of GE Australia, where he had a career of over 20 years, gave an entertaining and insightful talk on Australian Energy Policy and the Security of Supply to a recent luncheon seminar hosted by PPM.

Steve has a deep knowledge of the Australian energy sector and understanding of what has been driving the recent strong rises in energy prices. Steve, commented that the current energy policy difficulties and dramatic impact on electricity prices and had long been foreseen by the industry and how in his opinion many of the challenges were as a result of poor State and Federal Government Energy and Environmental policy. In particular he noted, that in his opinion the State Government had deliberately allowed their network operators, the owners of the poles and wires, to earn excessively high returns on their investments and thus roll out the ‘gold plating’ of the grid so that when the State Government sold Transgrid and partially sold Ausgrid and Endeavour Energy it maximised the one off proceeds for the State. What they failed to fully consider was the future impact of these decisions on retail electricity prices, as these ‘gold plated’ costs are directly passed onto consumers, with 60 percent of the increase in electricity prices to consumers came from this source.

Adding to the pressure on prices were two significant decisions that detrimentally affected both supply and demand. On the supply side, the decision by the French majority owners ENGIE encouraged by the Victorian Government, to close the Hazelwood power station in March 2017 which supplied to 25% of Victoria’s base load electricity and more than 5% of Australia’s total electricity supply, significantly reduced base load production capacity. And on the demand side, compounding this reduction in supply, the Victorian and Federal Governments gave the Alcoa Portland Aluminium Smelter $250 million in support to stay open. It is believed the Portland smelter consumes around 10% of Victoria’s electricity and as it is based on brown coal is a significant contributor to the state’s greenhouse emissions. The industry had not anticipated that this facility and significant base load demand would remain.

Rounding out his discussion in the state of the energy market in Australia, Steve provided insights into the current challenges in the Australian gas market. In relation to concerns often raised in the media about the shortage of domestic supply. He noted that had the Gladstone LNG terminals not been built and that the supply of gas to the east coast would have been less than at present, as none of the Queensland coal seam gas (CSG) fields would have been developed.

PPM began investing in the Australian energy sector via AGL before these market issues became news headlines – as discussed in the April Edition of the PPM Insights.

In fact at the time we began investing in AGL, electricity demand was falling but because AGL was the lowest cost generator in the National Electricity Market (NEM) we considered it to be the long term beneficiary of any change to the supply demand equation. In our opinion what the market failed to realise was that the LNG plants on Curtis Island at Gladstone are giant refrigerators and would use vast amounts of electricity! – requiring significant base load supply to support them. To make matters worse during ramp up the LNG plants had spare gas which was used to generate very low cost electricity, which seemed to lull the market into a false sense of security as to the status of supply.  All this time AGL was saying there was a looming shortage of gas both generally on the East Coast and specifically for it, hence the aim to develop central gas supply (CGS) particularly near Gloucester in NSW. In the event, public opinion and the “Shut the Gate” campaign won the day and we are short of gas! This situation has been compounded by power station closures in both Victoria and South Australia and public demand for renewable energy which is only just approaching economic viability.

Steve concluded that there are no simple or quick solutions for ‘fixing’ the challenges in the NEM, that governments at both the State and Federal level needed to work together to provide clarity and certainly around Energy and Renewables policies going forward, that would encourage the appropriate industry responses, although he noted that no other jurisdiction around the world has been able to do this well.

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