Boardroom Energy

This week:

  • China begins to gently trade its emissions 

  • Fast frequency response – coming to a grid near you in two and a bit years…

  • Gas sparks war of words

  • Chart of the week: Dunkelflaute 

In brief

As Former NSW Premier Jack Lang famously observed, “in the race of life always back the horse called self-interest – at least you know it’s trying”. The problem with a global environmental challenge like climate change has been to make emissions abatement an act of self-interest rather than moral obligation. This is why the United Nations Climate Convention (UNFCCC) has perpetually failed since its inception in 1991.

The chess pieces on global climate Plan B moved this week, with the EU announcing further implementation of its ambitious climate plan including carbon border tariffs on goods with high emissions. Spookily, as if by coincidence, the country with the biggest exports and highest carbon footprint, China, announced plans to commence a domestic emissions trading scheme.

Coincidence? We don’t think so.

The China-Light baseline and credit scheme is probably as much political colour and movement as the revived EU threat of carbon border tariffs. As we observed in January they probably breach WTO rules and will wreak havoc with what is left of the global free trade architecture if implemented. Watch this space.

New AEMO CEO Daniel Westerman had his “coming out” CEDA speech this week in Melbourne, just before it was locked down. Westerman used the speech to demonstrate a pivot from the policy focus of former CEO Audrey Zibelman to a return to operations – the O in AEMO – to make the grid big-renewables ready. Trouble is it got reported as committing Australia to 100 per cent renewables by 2025. Which is simply not possible.

Tightening gas-supply is pushing up prices in Australia which is pushing up wholesale electricity prices and sending industrial gas customers into a cold fury. This has triggered renewed calls to limit gas exports to ease prices and create more liquidity in the domestic market, but the Federal Government appears to be happy with the status quo.

In a sign of the times, while AGL is trying to split itself in two to repair its reputation, a queue is forming around the block to buy Spark Infrastructure’s distribution and transmission business. This may signal a back to the future moment, where the biggest energy companies end up being regulated asset owners.

And finally the protracted rooftop solar boom has revealed there may be some cowboys in the rooftop solar PV industry. Surely not!

China begins to gently trade its emissions

As the world’s biggest greenhouse emitter, it makes sense that China would require the world’s biggest carbon trading scheme. After making a commitment last October to reach net zero emissions by 2060, China is now implementing preliminary policy architecture to get there.

At least that is how it is intended to look. It might sound more impressive than it is. The Chinese emissions trading scheme will initially target 2225 power stations and factories. There won’t be hard caps on emissions, at least not initially. Instead each facility will be set allowances based on previous year’s performance, and there will be trading of permits on this basis.

This sounds more baseline and credit than cap and trade. The scheme will expand to seven more sectors over the next five years including chemicals, building materials, steel, cement and aviation. The starting price on emissions is around AUD$10 a tonne, lower than the $20 a tonne paid for abatement (ACCU’s) under the Federal Governments’ carbon credits scheme, and much lower than the EU carbon price trading currently at around AUD$90. It’s also lower than the true scarcity value of emissions valued at around USD$100 per tonne (AUD$135). Low cost emissions means low levels of emissions.

The progress on China’s emissions activity is driven, at least in part, by the threat of carbon based tariffs being imposed on its exports into key markets like Europe, and possibly one day the US.

The EU is proceeding with its plan announced in 2019 to impose carbon border tariffs on energy intensive products, justified by seeking to equalize the cost of its carbon price on EU manufacturers. This would impact Australia both directly and indirectly, as our coal is used to power economies like China, Japan and Korea that would be impacted by such tariffs.

China’s announcement last year on setting a net zero target by 2060 followed lengthy negotiations with the EU. It came just before the US election when it appeared that Democrat Joe Biden would be elected President, with the ensuing risk that the US might follow the EU down the carbon price and border tariff pathway.

That threat has been abated for now with the continued ascendancy of the Trump faction making such a deal challenging, but the risk remains. The carbon border tariff pathway still may be more bluff than reality, as it may breach WTO rules. China is responding to the bluff with one of its own.

This week’s announcement is part of that strategy. China has to balance its need to sustain economic growth in a giant and emerging economy with managing its relationships with key trade partners and only then its environmental responsibilities. This is pretty much like everyone else, except China is bigger, higher emitting and further back in the development pathway.

Fast frequency response – coming to a grid near you in two and a bit years…

The NEM’s rule maker, the AEMC, announced this week that it was approving a new rule to create a market in the NEM for fast frequency response. Aside from the revenue they earn providing energy to the wholesale market, generators and large scale storage units can earn extra revenue from fine tuning their output to help the market operator AEMO keep the system frequency stable. Whilst a highly technical area of the market it’s also absolutely essential. If you want to know what unstable frequency looks like, ask a South Australian who lived through the black system event in 2016.

These extra revenues generated from these frequency management services are generally small compared to energy revenues, so are collectively called ancillary services. As the grid transitions to more variable renewables, AEMO needs more of these services to keep the system secure. At the same time the traditional providers of many of these services – coal and old gas plants – are gradually exiting. So new services need to be defined and procured and new providers need to be found.

In this case, the service of fast frequency response is designed to extract a response within a second or two from service providers – the current fastest service sought is six seconds. AEMO will determine the exact specification of the service in consultation with stakeholders.

The required speed of response will suit the most flexible of resources, with batteries expected to be a mainstay although fast start fossil fuel plants like AGL’s Barker Inlet will also be in the market. Indeed, AEMC, which often takes flak for being insufficiently supportive of new technologies decide to promote the final rule by bracketing it with a draft rule they have just put out clarifying the rules around how storage is treated in the NEM and presenting the two as a set of pro-battery reforms.

But the many proponents of battery projects will have to wait a while to earn money from providing this new service, which AEMO will procure via a spot market co-optimised with the other FCAS markets and the wholesale energy market. As it will take AEMO some time to do the detailed design specification of the service and the market, it won’t commence until 9 October 2023. This date is earlier than AEMC had proposed in the draft rule. In any case, the revenue they can earn from this service is more likely to be a bonus than a key part of the financial business case.

Large users may not mind the wait. While they, like other system users, will benefit from the new services, the way they get charged for ancillary services is a bit of a problem for them. Retailers don’t want to take the risk of managing these charges they way they do for small customers, so they just pass through these charges to their large customers. Unlike the energy spot price there is currently no way to hedge these charges. Most of the time this risk is minor as the charges are small relative to the rest of the electricity bill, although when South Australia was islanded for a few weeks last year, FCAS charges exceeded wholesale energy charges. The AEMC was asked what it would do about helping large users manage these costs, but they responded that developing the necessary financial hedging markets was “not a function” of theirs. As the energy system transitions large users may find themselves increasingly exposed to these uncontrollable costs.

Gas sparks war of words

Open warfare has broken out between natural gas suppliers and large users (industrial and commercial). The latter have formally requested the government should intervene in the gas market, in the form of a joint letter to Resources Minister Keith Pitt from the heads of the Australian Industry Group and the Australian Workers Union. They have asked the Minister to invoke the Australian Domestic Gas Security mechanism, which is intended to ensure there is enough gas for domestic use, if necessary taking priority over export volumes. The letter claims there is “a real risk there will be a domestic shortfall in gas availability for our critical manufacturing industries…It is untenable that our domestic businesses are priced out of accessing this critical resource.”

Gas producers have responded, in the form of trenchant comments from their industry association, APPEA. APPEA’s CEO, Andrew McConville, claimed that any intervention would “decimate gas supplies” and that it would turn Australia into Venezuela. While this overblown rhetoric may be hard to take seriously, there will be plenty more to come if the government appears likely to act. And the underlying point that governments telling gas producers who to sell to (and if users have their way at what price) is likely to chill investment in the sector is a fair one.

Competition tsar Rod Sims, who has been firmly on the side of gas users cautioned against unrealistic price expectations, noting that the days of $4/GJ gas were long gone. He also noted that any intervention was a matter for the government, which while technically true is fairly restrained by Mr Sims’ standards, especially as he is one of the key advisers to the minister on whether the trigger should be pulled.

All this represents a headache for the federal government and shows the difficulties its so-called gas-led recovery will face. This line has created an expectation from users that government will step in to help them out, especially since the $4/GJ target came from the head of its manufacturing taskforce, Andrew Liveris. But if it does, it will clearly take serious flak from the powerful gas lobby. No wonder opposition leader Anthony Albanese has stirred the pot by supporting the calls for intervention.

As our blog last week noted, the run-up in domestic gas spot prices has several logical reasons, including supply constraints and a jump in demand from gas-fired generation to fill in for missing coal units at Yallourn and Callide. The ACCC’s netback price benchmark, which is supposed to indicate what a cap on contract prices should look like is on the rise, following NE Asian LNG price markers such as Platts’ JKM, and according to Mr Sims sits at around $11/GJ. This bodes ill for any manufacturers who need to recontract gas volumes in the near future. But high prices, while often caused by a tight supply/demand balance, are not in themselves evidence of a shortfall. Notably, AEMO, another key source of advice on the trigger decision has yet to offer their opinion, although as recently as March their annual forecast report indicated they didn’t expect a shortfall in the next couple of years. So, whether the government can or even wants to find a rationale to help out the manufacturers remains to be seen. They may prefer to resolve this informally by leaning on the producers without actually triggering any obligations on them. In which case expect the war of words to be a protracted campaign.

Chart of the week – Dunkelflaute

Dunkelflaute is the German word for “dark and still”, or those times when the sun isn’t shining, and the wind isn’t blowing. As renewables grow to dominate power grids, keeping the lights on during Dunkelflaute periods when the renewables are off will be increasingly important. So, we have started tracking it for the NEM. There is no clear definition of how little renewables need to be on to be “Dunkelflaute”, but we have chosen 15 per cent as a reasonable threshold. Chart 1 shows the capacity factor of renewables throughout the month – the dotted line is 15 per cent.

Chart 1: Capacity factor of renewables in the NEM, June 2021

Source: Boardroom Energy, NEM-Review

Chart 2 below shows the number of consecutive hours of Dunkelflaute conditions on each day of June. As chart 1 below shows there were six days in June when Dunkelflaute persisted for at least 16 hours. Four of these were consecutive days, and the longest Dunkelflaute was 19 hours, on 3-4 June.

Chart 2: consecutive hours of renewables capacity below 15 per cent

Source: Boardroom Energy, NEM-Review

As things stand, periods like these gets filled by coal and gas. As fossil plants exit the system, then we will need long duration storage, noting that batteries typically have 2-4 hours of storage at their maximum capacity.