Source document: https://docs-lawep.s3.us-east-2.amazonaws.com/1697639416486.pdf (Australia)
Renewable electricity generation policies in the broader electricity market context August 2014 The performance and management of electricity network companiesSubmission 32 - Attachment 4 1 Introduction and background ...................................................................................... 6 2 A history of government involvement in electricity production ............... 7 3 Incumbency and network access ............................................................................. 14 4 Vertical integration, electricity market design and market power ............. 16 4 .1 Vertical integration ....................................................................................................... 16 4.2 NEM market design ............................................................................................................ 17 5 When is a subsidy not a subsidy?
............................................................................ 20 References ............................................................................................................................. 23 2 The performance and management of electricity network companiesSubmission 32 - Attachment 4 EXECUTIVE SUMMARY The Report of the Expert Panel, “Renewable Energy Target Scheme” suggests that a continuation of the RET in its current form will result in a wealth transfer from fossil fuel generators (principally coal-fired generators) to renewable generators.
The Panel estimates that this is worth $22bn (present value), over the next 15 years, or $1.5bn per year.

On the other hand, the International Monetary Fund1 focussing just on climate impacts, said that in Australia in 2011 post tax subsidies to coal were worth 0.55% of Australia’s GDP, or circa $6bn per year.

The Organisation for Economic Co-operation and Development2 estimates direct (non climate externality) subsidies for coal of $173m in 2011.
The extent of fossil fuel and renewables subsidies in Australia and internationally is of course contentious and extensively debated.

This paper has a much narrower scope, focussing instead just on renewable electricity generation policies in Australia in the context of the electricity market in general and Queensland in particular.
It examines in turn: • Historic norms for the involvement of the Government in the electricity industry in Australia, from the industry’s early beginnings to the present, through the electricity industry market reforms since the 1990s; • The arrangements for transmission access and the extent to which these provide advantages to fossil fuel generators relative to renewables; • The impact of vertical integration, the design of the electricity market and exercise of market power on fossil fuel generators relative to renewables; • The definition of “subsidy” in electricity markets.
The main points in this report follow.

1 International Monetary Fund (2013).

Energy Subsidy Reform: Lessons and Implications.

2 OECD (2012).

Inventory of Estimated Budgetary Support and Tax Expenditures for Fossil Fuels 2013.

OECD Publishing.

3 The performance and management of electricity network companiesSubmission 32 - Attachment 4 Government and electricity production Other than from its earliest days, Australia’s state governments have led the development of the industry.
For much of the period up to the market-oriented reforms in the 1990s, electricity was seen as an “engine for growth” in the economy and an essential social product.

Since market reforms, government has continued to be involved through programs such as the Queensland Gas Scheme which stimulated the development of the Queensland coal seem methane industry.

As a major investor in generation, the Queensland Government still has a substantial commercial stake in the industry.
In this context, the promotion of renewable generation is unremarkable, it is simply the latest incarnation in a long history, of government involvement in electricity production albeit that hitherto such involvement has focussed mainly principally on the exploitation of Australia’s fossil fuel capacity.
If there is perhaps one significant conclusion from the history of the development of the electricity industry in Australia, it must be to question whether significant electricity generation investment – renewable or not - will ever occur without sympathetic government policies Transmission access Generators in the National Electricity Market (NEM) do not pay to use the transmission system, although they do pay to connect to it.
However the backbone of the electricity sector was developed in conjunction with the development of Australia’s fossil fuel (and in Tasmania and the Snow Mountains, hydro) capacity.

New entrant renewable will be at a disadvantage relative to the incumbents to the extent that their generation capacity is not close to the main transmission lines originating in Australia’s coal and gas basins.
In this sense, new entrant renewables are at a competitive disadvantage relative to incumbent fossil fuel generators.

Vertical integration, electricity market design and the exercise of market power The Queensland retail electricity market is highly concentrated, even more so than any other region in the NEM.

The Queensland Government has concluded that this 4 The performance and management of electricity network companiesSubmission 32 - Attachment 4 disadvantages its generators.
We agree and note that the same concern applies to new entrant generators not developed by the dominant Queensland retailers.

On market design, the NEM is a mandatory energy-only market with a very high price cap.

Historically prices in the NEM have been extremely volatile, even more so than in other countries.

There is evidence that extreme prices have at times reflected the exercise of market power, by fossil fuel generators.
Fossil fuel generators benefit disproportionally from such market power, as a result of their superior controllability relative to renewable generators.

When is a subsidy not a subsidy?

The life cycle average production cost of electricity from renewable sources has reduced rapidly in Australia and in other countries.

Many factors have caused this.

Increasingly, renewable electricity is beginning to displace fossil fuel capacity.
As a result of this there is an increasing trend, internationally, towards the introduction of capacity payments, much of which will be paid to fossil fuel generators to encourage them to remain available to produce electricity.

Such payments might be seen as payments necessary to ensure reliable supply in a market that fails to adequately reward generator availability.
However these availability payments might just as reasonably be subsidies to fossil fuel generators that are no longer able to compete with renewable generators.

At the least, we might conclude that in electricity, the definition of subsidy is susceptible to different perspectives on the correct design of an electricity market.

This paper might be read as suggesting that subsidies for renewables are justified because fossil fuel generators are also subsidised, and hence that two wrongs make a right.
This would be a misreading.

The main point is that electricity markets are highly regulated constructions, not markets in the sense commonly understood.

In this context describing the RET as a “market” intervention and counting its payments as “subsidies” is incorrect.

Such an approach ignores the many ways that incumbents – who are principally but not exclusively fossil fuel generators producers – are advantaged through history and the current arrangements.
5 The performance and management of electricity network companiesSubmission 32 - Attachment 4 1 Introduction and background The contemporary debate about the promotion of renewable electricity in Australia is particularly focussed on the size of the p a y m e n t attributable to the Renewable Electricity Target (RET).

This is hardly surprising, such payments are visible and can be calculated quite precisely for the past and estimated within bounds for the future.
These payments have contributed, although much less than other factors, to Australia’s now very high electricity prices.

However the calculable payment does not provide the full story.

Understanding the broader context is important.

This paper tries to establish that broader context.

It does not explore the issue of external (principally climate) costs associated with fossil fuel combustion.
Neither does this paper attempt a comparison of the subsidies provided to renewables in comparison to the direct subsidies provided in the production and consumption of fossil fuels.

Rather the focus in this paper is primarily on establishing the electricity market context for the promotion of renewable electricity.

The paper examines evidence in three areas: 1.

An historic review of government policies affecting development of the electricity industry.
This concludes that policy support for renewables is a continuation of government involvement in the development of the electricity industry that can be traced back to the industry’s beginning.

2.

An examination of the arrangements for transmission access and an analysis of electricity market design and of the actual market arrangements in Queensland.

From this we conclude that renewable generators in general and new entrant renewables in particular, are playing on a field that is tilted against them.
3.

The definition of subsidies.

In particular, in electricity markets around the world availability / capacity payments are being introduced to encourage fossil fuel generators that can no longer compete with renewables, to remain in the market.

Are such payments subsidies?


6 The performance and management of electricity network companiesSubmission 32 - Attachment 4 This document is best described as a “think piece”, to encourage readers to c o n s i d e r renewable electricity policies i n a broader context.

If, at the least, it stimulates debate and encourages the reader to see other perspectives, it will have achieved its aim.
The paper is set out as follows: • The second section starts with a brief retrospective of the development of the electricity industry in Australia in general and Queensland in particular.

This provides context to the industry we see today.

It addresses issues such as why the industry is the way it is, who bore the financial and development risks and how was it shaped by the policy objectives of preceding governments.
The last part describes the industry as it is today and contrasts the commercial environment facing new entrant renewable (and non-renewable) electricity generators, with the environment f a c e d b y incumbent, predominantly fossil fuel producers.

• The third sections examines the arrangements for network access.
• The fourth section examines the vertical integration of generation and retailing, and aspects of the design and operation of the electricity market that affect renewable and fossil fuel generators differently.

• The fifth section examines contemporary changes in the design of electricity markets in other countries, that have been motivated primarily to ensure the continued presence of fossil fuel generators and that are no longer able to compete with renewables.
2 A history of government involvement in electricity production 7 The performance and management of electricity network companiesSubmission 32 - Attachment 4 The production and distribution of electricity in Australia started in the 1880s, as in many other countries with small, decentralised typically privately owned businesses, exploiting opportunities to apply electrical current in street lighting, heating and in motors.
The primary energy source for this depended on locally available resources which typically included heavy fuel oil, steam and run of river hydro.

In Queensland, the pressure from artesian water bores found early application in driving generators.

Local authorities quickly found a role as electricity buyers (for street lighting and other essential services) and as co-ordinators of shared electricity networks.
As the industry grew, local and state governments became increasingly involved as electricity producers and distributors so that by 1937, 86% of the electricity industry in Australia was publicly owned (Boehm 1956).
State governments progressively took over from local authorities in production and distribution, starting with the formation of a statutory commission in Tasmania in 1914 (followed by the creation of the Hydro Electric Commission in Tasmania in 1930) and the State Electricity Commission of Victoria in 1918.

A statutory corporation was created in Queensland in 1938.

In Queensland, local government and local private monopolies retained a role for a longer period than elsewhere in Australia.
Private, local, monopolies undertook electricity supply to Brisbane, the Gold Coast and Toowoomba until the 1950s.

Inland local authorities continued to play a role in electricity provision until the late 1980s.

Through-out this period, governments initiated and oversaw the development of the electricity industry.
Major investments in networks and in both renewable (Tasmania and Snowy Mountains, Wivenhoe in Queensland) and fossil fuel generation capacity (Latrobe Valley and Hunter Valley) were arranged and funded by state governments.
The public attitude (and hence expectations of governments) in relation to electricity provision were visible, for example in the views of a Royal Commission that South Australian Premier, Thomas Playford set up as a precursor to the 8 The performance and management of electricity network companiesSubmission 32 - Attachment 4 nationalization of the Adelaide Electric Supply Company.
The Commission declared that “an adequate supply of electricity at reasonable rates is of the utmost importance to the community particularly for the development of industry”.
(Royal Commission 1946) Playford’s subsequent nationalisation of the Adelaide Electric Supply Company responded to the Government’s view that electricity supply should be an engine for industrial growth, that it had obligations to electrify rural areas even if not profitable and that the industry should drive the development of regional resources (in South Australia specifically, the Leigh Creek sub-bituminous coal resources) (Spoehr 2003).
Judged by the observed outcomes around Australia, this seems to generally characterise the various state governments’ objectives for the industry.

The “reform” era In each state and territory of Australia statutory corporations providing electricity at cost, perhaps running small surpluses in some cases and funded substantially by government borrowing continued until the 1990s.

By this time the vast majority of Australia’s homes and farms had been connected to the various grids.
Needs had been met and policy makers began to turn increasingly towards concerns about the productivity and efficiency of the industry.

From the mid 1990s, Australia began to catch a wave of reform and "restructuring that had begun in Britain from the 1980s.
The major elements of this "re fo rm " in c lu d e th e v e rtic a l s e p a ra tio n o f e le c tric ity p ro d u c tio n , tra n s m is s io n , distribution and supply, the introduction of an electricity market, the independent economic regulation of network monopolies and progressive introduction of retail competition.

The rationale for this reform was, in part, the perception that the statutory corporations were unproductive.

(Pierce, Price et al.


1995) The post-reform industry model - the one that currently pertains - is meant to "privatise" 9 The performance and management of electricity network companiesSubmission 32 - Attachment 4 investment decision-making at least in respect of electricity production and retailing.

Generally the reform has also meant privatisation.


In Queensland, government direction and ownership of the industry facilitated exploitation of Queensland's inland coal resources (the Kogan Creek, Callide and Tarong power stations in the west, Stanwell to the south and Gladstone in the north albeit plus 200km of rail line).
Before the creation of the Queensland Gas Scheme (discussed later) the Queensland government also invested in gas generation (for example Swanbank E commissioned three years before the Queensland Gas Scheme was developed (in 2005), and the earlier development of Barcaldine).

Queensland remains now one of the last states in the NEM to still retain a significant amount of generation in government ownership.
While the Queensland Government is no longer expanding generation capacity, it remains by far the most significant owner of generation in Queensland and it has continued to refurbish capacity (for example most recently at the Tarong Power Station).

While the post-reform industry model was meant to (and has meant) much less direct government investment in generation, the Queensland Government has nonetheless sought to stimulate investment in generation in various ways.
For example, the Queensland Gas Scheme provided financial support for the development of large-scale combined cycle gas generation in Queensland from 2005 (until its closure in 2013).

Under this scheme new capacity (e.g.

Braemar, Condamine, Darling Downs and Oakey) was developed by private investors and partly financed through a mandatory obligation on retailers to procure a percentage of their sales from gas-fired sources.
The Queensland Gas Scheme is a model of government involvement in the generation side of the industry, post reform.

Pre-reform, the Government invested directly to a c h i e v e i t s p o l i c y o b j e c t i v e s ( i n c l u d i n g t h e 10 The performance and management of electricity network companiesSubmission 32 - Attachment 4 d e v e l o p m e n t o f Q u e e n s l a n d ' s c o a l resources, and related rail infrastructure).
Post reform, the Government was able to deliver policy objectives (in this case, the development of Queensland's coal seam methane resources) by placing obligations on retailers, rather than directly investing itself3.

The contemporary situation Queensland Government-owned generators CS Energy and Stanwell Corporation together own a little over half the grid-connected generation capacity in Queensland.

Even more significantly they control twice as much "base load" (i.e.
relatively low variable cost) generation than is owned by private generators.

Other than Millmerran, and half of Callide C, CS Energy and Stanwell control all the coal generation capacity in Queensland.

Most recently Stanwell has spent $38m refurbishing its mothballed Tarong generating units and expanding capacity through a $50m investment in the adjacent Meandu coal mine.
However through the Queensland Gas Scheme and its solar feed-in tariff, successive Queensland governments seem to have made decisions that have jeopardized its power generators’ commercial position, in pursuit of other policy goals.

The relative importance of various policies however changes over time.

The current Queensland Government has committed to seeking an electoral mandate to privatise its generators.
In its submission to the most recent review of the RET4, the Queensland Government has emphasised that renewable and alternative energy solutions should be commercially viable and free of government subsidies.

It would be remiss not to at least be cognisant that the Government has conflicting interests and inevitably this will affect the position the Government takes on relevant issues.

3 Noting again the exception of Swanbank E and Barcaldine.

4 Warburton, R., B. Fisher, I. t. Veld and M. Zema (2014).
"Renewable Energy Target Scheme: Report of the Expert Panel."

11 The performance and management of electricity network companiesSubmission 32 - Attachment 4 Conclusions What are the main points to be taken from this discussion of government involvement in the electricity sector in general and in Queensland in particular?

The RET is a system of subsidies to promote the expansion of renewable generation.
However, besides the fact that it promotes renewable electricity generators rather than fossil fuel generators, in substance it simply continues a tradition of government involvement in electricity supply that can be traced back to the early history of the electricity industry.

Before the competitive reforms of the 1990s this tradition took expression in direct government investment and control of generation.
Since the reform, it has played out through policies very similar to the RET – such as the Queensland Gas Scheme – and to a lesser extent by continued investment by government through the generators that it owns.

The RET is sometimes characterised as a market distortion.
Measured against new entrant fossil fuel generation and ignoring externalities such as greenhouse gas emissions from fossil generation, this may be a valid criticism: the RET does provide benefits that new entrant fossil fuel generators can not access.
But those characterising the RET as a market distortion should be mindful that the same criticism would then apply to the vast bulk of existing generation developed either by government-owned corporations or facilitated by government-imposed obligations such as the Queensland Gas Scheme, that function just like the RET.

Incumbents seeking to protect their position by pulling up the drawbridge might understandably not want the same conditions that brought them into existence to also apply to new entrants.
Historic advantages should not be ignored.

And if precedents are to be rejected there must be reason for this, beyond that this is what the incumbents prefer.

It might be argued on the other hand that two wrongs don’t make a right, i.e.

that the subsidies of the past must be stopped.

If so, it would be helpful to understand the economic arguments for and against this.
Notwithstanding such arguments, if there is perhaps one significant 12 The performance and management of electricity network companiesSubmission 32 - Attachment 4 conclusion from the history of the development of the electricity industry in Australia, it must be to question whether significant electricity generation investment – renewable or not - will ever occur without sympathetic government policies.
13 The performance and management of electricity network companiesSubmission 32 - Attachment 4 3 Incumbency and network access The backbone of Queensland's high voltage transmission network has been shaped by - and has in-turned shaped - its generation resources.
The 275 kV networks connect Callide, Gladstone and Stanwell to load on the coast and to their south, and likewise the 330 kV and 275 kV networks connecting Milmerran, Kogan Creek and Tarong with loads to their south and east were driven by the exploitation of Queensland's coal and gas resources.

This transmission backbone was developed by the government-owned Southern Electric Authority of Queensland, which also developed most of the coal-fired generation (which the government also owned).
There is nothing unusual in the integrated development of transmission and generation in Queensland.

The same phenomenon has characterised most of the network development in the NEM by state corporations that combined generation and transmission.

Since the reform that created the NEM and the consequential vertical separation of generation and transmission, generators have non-firm (i.e.
non-guaranteed) access to the transmission system (excluding connection) without incurring charges for the use of the network.

This applies to new as well as incumbent generators.

However generators (and end users) pay for their connection to the shared grid.

The boundary between connection and shared assets can be very complex and can change over time.
A transmission line that may start life as a connection asset can become a shared asset later when other generators or users connect to the line or the previous connection line is connected to other lines on the shared network.

It is not fair to conclude that new entrant generators (whether renewable or not) are disadvantaged relative to incumbents in respect of use of the network.
But it would be reasonable to conclude that they are disadvantaged relative to incumbent generators who have not had to pay for connection to the shared network.

Depending on the way that the connection policy is implemented, this can be a significant disadvantage in some cases.

14 The performance and management of electricity network companiesSubmission 32 - Attachment 4 It is difficult to argue that connecting parties should not be responsible for their connection to the shared network.
However, inevitably this creates an unfair competitive advantage for new entrants relative to incumbents who have not had to bear the cost of connection.

This disadvantage applies to new entrants, whether they be fossil fuel generators or renewable generators.
However the disadvantage is likely to be greater for renewable generators, since the existing transmission network has been designed to facilitate the exploitation of fossil fuels, both gas and electricity, and as such new entrant fossil fuel based generators are likely to face lower connection costs than renewable generators.
15 The performance and management of electricity network companiesSubmission 32 - Attachment 4 4 Vertical integration, electricity market design and market power This section examines the vertical integration of generation and retailing and aspects of the design of the National Electricity Market (NEM).

The focus is on the impact on incumbents relative to new entrants, and on fossil fuel based electricity producers relative to renewable based electricity producers.
4.1 Vertical integration Origin Energy and Ergon each supply about a third of Queensland's electrical load.

AGL Energy supplies about a fifth and the remaining 15 percent is supplied by various privately-owned retailers.

Of these three retailers, Ergon supplies a protected market for sales to customers that consume less than 100 MWh per year since the Uniform Tariff Policy forces competing retailers to charge much higher network tariffs.
The retailers do not have generation capacity sufficient to match their retail loads.

Part of the reason for this is that around two-thirds of Queensland’s installed generation capacity is owned or controlled by its two state- owned generators, which are not integrated with electricity retailers.

As a result, the Queensland electricity market is one of the least vertically integrated in the NEM.
Despite the low level of vertical integration in Queensland, the Queensland Government has concluded that vertical integration has contributed towards lower pool and forward prices and has reduced demand for the state generators' production5.

What does this mean in deciding whether the actual market arrangement in Queensland provides a competitive advantage to incumbents relative to new entrants?
While we don’t negate the Queensland Government’s concern about the impact of vertical integration, we suggest that the main concern is that the very high level of retail concentration (three retailers share 85% of the market and of this one retailer with around 33% effectively faces limited competition for most of its custromers).

The 5 Government, Q.

(2010).

Shareholder Review of Queensland Government Owned Corporation Generators.

Brisbane.
Brisbane.

16 The performance and management of electricity network companiesSubmission 32 - Attachment 4 consequentially diminished rivalry means that in their negotiation with the dominant incumbent retailers, new entrant generators can expect outcomes that are less favourable than those available to the incumbent retailers 4.2 NEM market design The NEM is a mandatory energy-only market i.e.

only energy that is actually produced is compensated in a mandatory market.
This is a relatively unusual market design by international standards: most electricity markets reward generators for being available to produce (known as capacity or availability payments) and also for producing (known as energy payments).
Other features of the NEM are notable: it is mandatory market for those generators above a certain size (most electricity markets are voluntary), its trading prices are calculated every five minutes (this is the shortest trading period in any electricity market) and it has a very high cap on prices ($13,100/ MWh).

For these reasons, amongst others, the NEM has had a record of very high price volatility and intervals of extreme pricing.
This is very unusual by comparison with experience in electricity markets in other countries (Mountain 2013).

A very volatile market with short trading intervals provides strong rewards for those generators that have the flexibility to respond to those high prices.

If those high prices reflect the reasonable operation of a competitive market (i.e.

they are not influenced by the exercise of market power) then the rewards for flexibility (the ability to increase supply at short notice) may be reasonable.
However the opportunity to achieve extraordinary prices creates incentives to exercise market power.

This has been an enduring issue in the NEM particularly in South Australia and also in Queensland.

Mountain (2013) documents the situation in South Australia.

That research showed that between 2006 and 2011 wind farms received prices that were consistently around $6/MWh or 16% below the average annual price (excluding the top 72 half hourly settlement periods).
However in those extreme price half-hourly settlements periods – most of which were associated with the exercise of market power - wind farms received substantially lower prices (up to 48% lower) than the supply-weighted average prices, particularly in 2008 and 2009 and to a lesser extent in 2010 and 2011.
Renewable generators have been significantly 17 The performance and management of electricity network companiesSubmission 32 - Attachment 4 disadvantaged relative to fossil fuel electricity producers, not primarily as a result of their intermittency, but because fossil fuel generators were able to obtain greater benefit from their creation of market power.
In Queensland, in its 2013 State of the Energy Market report6 the Australian Energy Regulator has raised concerns about the exercise of market power in Queensland citing events towards the end of 2013, attributable to the exercise of market power resulting from plant inflexibility in response to relatively small changes in demand even at times of relatively low regional peak demand.

This exercise of market power has led to price spikes near the market price limit.
As in South Australia, fossil fuel generators will have been are able to take advantage of such price spike events, disproportionately relative to renewable generators whose production is affected by the availability of the uncontrollable renewable resource.
Another area of relative disadvantage to renewable generators is the exercise of market power as a result of dominant fossil fuel generators exacerbating, and in some cases creating, bottlenecks on the transmission network in order to raise market prices.

For example, in Queensland, Australian Energy Regulator (2013) cites an instance in 2013 where CS Energy, which controls generation at both end of the Calvale to Wurdong transmission line (specifically Gladstone to the north and Callide to the South).
CS Energy bid these plants into the NEM in such a way that this transmission line became congested.

The Australian energy market operator had no option but to constrain on higher cost generation north of the congested line, and constrain off generation south of the congested line.
All uncontracted generators in Queensland that were producing at the time of the higher prices (and who had not hedged their spot price exposures) would have benefitted from the higher spot prices that arose as a result of this exercise of market power.

However the greater controllability and flexibility of fossil fuel generators means that they are able to rapidly respond to market power instances such as these.
This is likely to mean that fossil fuel generators benefit disproportionately relative to renewables, from instances of market power such as these.

6 Australian Energy Regulator (2013).

State of the Energy Market.

18 The performance and management of electricity network companiesSubmission 32 - Attachment 4 19 The performance and management of electricity network companiesSubmission 32 - Attachment 4 5 When is a subsidy not a subsidy?
The previous sections of this paper considered various ways in which the design of electricity markets and transmission access arrangements provided a playing field that offers relative advantage to incumbents compared to new entrants, or for new entrant fossil fuel generators relative to new entrant renewable generators.
This chapter examines how the cost structure (the relative level of capital versus operating costs) of renewable generators compared to fossil fuel generators is affecting outcomes in electricity markets.

Responding to this is stimulating changes in the design of electricity markets – the creation of regulated payments for capacity, which support fossil-fuel generation capacity.
This raises the question of whether such capacity payments should be defined as subsidies or legitimate charges to ensure security of supply.

The distinguishing feature of renewable generators is that they have negligible or no fuel cost as a result of their access to a renewable primary energy source.

While renewable generators do incur variable operating and maintenance costs, these non- fuel operating costs are typically lower than for comparable fossil fuel plant.
Renewables’ disadvantage lies in lower throughput (since the primary energy source – wind, sun, biomass and so on) while plentiful at some times are in short supply at other.

The intermittency of some7 renewable plant diminishes their ability to maximise their production at the times most valued in the market.

Renewables have historically also had capital costs per unit of capacity that were significantly higher than for fossil fuel plant.
The combination of these factors has meant that renewable plant has long been more expensive relative to both incumbent and new fossil fuel generators.

However this conclusion is increasingly less valid in Australia.

For example, the Snowtown 2 270 MW wind farm in South Australia – currently nearing completion – will have required an outlay of $439m or $1.63m per MW.
This wind farm is expected to produce 985 GWh per year for at least 25 years.8 Assuming a 10% cost of capital, non- fuel operating costs of $10/MWh and fixed operating costs of $25,000 per MW per year, we calculate the levelised cost of electricity produced at this wind farm will be $65 per MWh.

By comparison, the recent “Sustainable Resource Feasibility Study” undertaken 7 Biomass is typically seasonally affected although operating constraints can affect flexibility in the short term.
8 Trustpower, “Snowtown Stage 2, July 2012, Investment and analyst briefing”.

20 The performance and management of electricity network companiesSubmission 32 - Attachment 4 for Townsville Enterprises9 , noted comparable levelised production costs for coal fired plant of around $80/MWh.
While actual generation costs will vary from plant to plant for many reasons, the general conclusion that the least expensive large scale new entrant renewable generation is competitive with the most competitive large scale new entrant fossil fuel generation seems to be robust10.

The implications of this shift is profound.

The market for future investment in large- scale electricity production in Australia is likely to be dominated by renewable sources.
This has been the case for much of the developed world over the last decade, even in the absence of significant policy support for renewables.

While Australia has historically had access to relatively inexpensive fossil fuel resources, ever deeper international linkage in coal and now gas is resulting in significant domestic fossil fuel price rises, and in the case of gas also concerns about resource security, at least for consumption in domestic markets.
This is diminishing the competitiveness of fossil fuel sources relative to renewables.

Indeed the Climate Change Authority’s analysis of the RET (Climate Change Authority 2012) concluded that by 2030 there would be the same aggregate installed capacity of renewables by 2030 whether or not the RET was in place.

Over time the increasing dominance of renewable capacity will displace fossil capacity.
However, with limitations in renewable resource availability, a combination of fossil- fuel generation back up, demand response and storage will be needed to ensure supply.

Market mechanisms need to ensure that such back-up resources are available to produce on demand.

To achieve this, in various electricity markets (regulated) capacity payments have been developed to compensate fossil fuel capacity for being available to produce.
In the case of Britain’s recent changes, the European Commission recently 9 GHD 2014.

“North and North West Queensland Sustainable Resource Feasibility Studies.

10 It should be emphasised that this relates to the competitiveness of new entrant technologies against each other, not the competitiveness of new entrants against incumbents.

It should also be noted that that competitiveness of renewables is even better in distributed application.
At the point of use, rooftop PV is significantly more competitive than grid-supplied electricity.

For example the levelised cost of rooftop PV installed in Australia between 2010 and 2013 averaged $160/MWh (Mountain, B. R. and P. Szuster (2014).

Australia's solar roofs: disruption on the fringes or the beginning of a new order.

Distributed Generation and its Implications for the Utility Industry.

F. P. Sionshansi.

San Franscisco, Academic Press.).


Further reduction in PV costs will mean that that is significantly lower now.

By comparison, average household electricity are around $320/MWh.

21 The performance and management of electricity network companiesSubmission 32 - Attachment 4 approved these.

The British arrangements provide a GBP15bn budget (paid for by consumers) for payments to eligible generators, for 15 years.
France and Italy are shortly to introduce similar mechanisms and in Germany a similar scheme has been announced for introduction by 2017.

The purpose of the capacity mechanism is, essentially, to provide additional payments to fossil fuel generators that are no longer able to compete with renewables11.
Should these payments (which are recovered from electricity consumers through regulated charges) be seen as subsidies to fossil fuel generators that are no longer able to compete with renewable generators12?

Or, should they be seen as payments to ensure security of supply when renewable resources are not available?

Both interpretations are plausible, and their difference reflects different views on the definition of a market and the adequacy of the compensation it provides.
11 Payments for demand reductions are also possible, but these are likely to be less significant.

12 The argument being that if the back-up service provided by fossil fuel generators was really valued in the market, energy consumers would be prepared to pay for it and so it would not be necessary to introduce capacity payments.

On this argument, capacity payments are therefore just a form of subsidy.
22 The performance and management of electricity network companiesSubmission 32 - Attachment 4 References Australian Energy Regulator (2013).

State of the Energy Market.

Boehm, E. A.

(1956).

"Ownership and control of the electricity supply industry in Australia."

The Economic Record, XXXII Climate Change Authority (2012).

Renewable Energy Target Review: Final Report.

Melbourne.

Government, Q.

(2010).

Shareholder Review of Queensland Government Owned Corporation Generators.

Brisbane.
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International Monetary Fund (2013).

Energy Subsidy Reform: Lessons and Implications.

Washington, International Monetary Fund,.

Mountain, B.

(2013).

"Market Power and Generation from Renewables: the case of Wind in the South Australian Electricity Market."

Economics of Energy & Environmental Policy 2(1).

Mountain, B. R. and P. Szuster (2014).

Australia's solar roofs: disruption on the fringes or the beginning of a new order.
Distributed Generation and its Implications for the Utility Industry.

F. P. Sionshansi.

San Franscisco, Academic Press.

OECD (2012).

Inventory of Estimated Budgetary Support and Tax Expenditures for Fossil Fuels 2013.

OECD Publishing.

Pierce, J., D. Price and D. Rose (1995).

The performance of the NSW Electricity Supply Industry.

Reserve Bank of Australia.

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23 The performance and management of electricity network companiesSubmission 32 - Attachment 4