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Speech to AEMC by Lillian Patterson

On Wednesday 4 December, the CEC's Director of Energy Transformation, Lillian Patterson, gave the following speech at the Australian Energy Market Commission's Pre-Determination Hearing on Transmission Loss Factors.

Thank you to the Commission for the opportunity to contribute to your further thinking on the transmission loss factor rule change proposal.

The Clean Energy Council (CEC) is the peak body for the clean energy industry in Australia. We represent and work with hundreds of leading businesses operating in renewable energy and energy storage along with more than 6500 rooftop solar and battery installers. We are committed to accelerating the transformation of Australia’s energy system to one that is smarter, cleaner and more affordable.

There is no denying that business had been booming for renewable energy in the last few years. The 2020 Large-scale Renewable Energy Target (RET) was a highly successful policy that drove unprecedented levels of investment in new utility-scale generation. Between 11 and 12 large-scale projects equating to around 1.5 to 2 GW were financially committed in each of the quarters from Q2 2018 through to Q4 2018.

Since then, however, the numbers of financially committed projects have significantly dropped off. In each quarter of 2019, between two and five projects have been financially committed, equating to between 270 and 630 MW each quarter. If you look at annual numbers, in 2018 there were 43 projects at a total of 6.3 GW. In 2019, that has dropped off considerably with 15 projects at a total of just under 2 GW. We have had as many financially committed projects for the whole of this year as we had each quarter last year.

It was unfortunate but understandable that investment would drop off with the conclusion of the RET. However, there is a significant transition underway and chaos will inevitably result from leaving the job half done.

Unprecedented levels of new investment will continue to be required to maintain reliability and stabilise wholesale prices as a number of large thermal generators retire and need to be replaced. Ideally, we should be building enough new generation before they retire to ensure that energy consumers are not surprised by spikes in their power bills or gaps in supply.

In terms of the retirement of thermal plants, coal-fired generation equating to around 70 TWh of energy each year – close to one-third of total National Electricity Market (NEM) consumption – is expected to close between now and 2040. The Australian Energy Market Operator's (AEMO) neutral Integrated System Plan planning scenario projects the lowest cost replacement for this retiring capacity will be a portfolio of resources, including 28 GW of solar and 10.5 GW of wind. In total, that represents 38.5 GW over the period or just under 2 GW a year for the next 20 years. Given we have had about that amount of financially committed projects this year and some of those were driven by the RET, we can only assume that that number is likely to drop further.

In dollar figures, AEMO has said we need $3.5 billion of new investment in generation every year until 2040. That is what is needed to maintain reliability through ensuring sufficient new generation replaces exiting coal-fired generation and to put downward pressure on wholesale prices. Generation investment doesn’t just assist to meet the National Electricity Objective (NEO) in delivering benefits to end use consumers. It also means jobs and regional development.

For that necessary investment to prevail, we need to ensure an encouraging investment environment for new generation in Australia. The current marginal loss factor (MLF) framework is not assisting the business case for new generation in this country.

MLFs are a significant issue for CEC members. In our most recent survey of the CEOs of our member companies, MLFs was recognised in the top five business challenges facing the industry at the moment.

We are seeing MLF risk manifest itself in increased risk premiums for new projects. A higher cost of capital increases the levelised cost of energy, resulting in higher prices for consumers. It is already deterring investment in new generation at a time when new generation investment is critical. We do not believe this has been adequately discussed in the draft determination.

Our members suggest that a 1 to 2 percentage point premium is currently being added to the cost of capital for new projects in Australia as a result of MLF risk. This equates to an additional $10-15 per megawatt added to renewable energy projects.

No other market in the world has MLF volatility like we have in the NEM. Compared with comparable markets such as the US and UK, Australia has the highest cost of capital in the world for new renewable generation build. CEC members have indicated a weighted average cost of capital (WACC) of 8-10 per cent in Australia, depending on the level of contracting. At the lower end, 8 per cent is for a fully contracted project. At the higher end, 10 per cent is for a fully merchant project. This compares to 5-6 per cent in the US and UK.

Given these levels of capital costs, it is entirely possible that renewable investors will withdraw from the Australian market to invest in markets with less loss factor volatility.

It is not that clean energy developers deny that there are real physical losses on the system that change instantaneously and need to be accounted for. But the current market framework for allocating these losses is no longer fit for purpose. In an energy market that is changing rapidly, the current regime creates enormous risk for investors.

One of the key issues with MLF risk is that it is unhedgeable. The Australian Energy Market Commission (AEMC) has rightly suggested that a generator’s MLF risk could be managed by entering into long-term power purchase agreements. This, however, is not the industry standard. Customers do not want to take on MLF risk. In the handful of situations where the offtaker has agreed to take on MLF risk, 100 to 150 basis points have typically been added to the contract for this risk.

The CEC was encouraged by the AEMC’s investor survey which looked to gather information about the quantitative impacts associated with project financing. In particular, we supported that it specifically looked to carve out the impact on the WACC of the current loss factor methodology. We have urged our members to complete the survey and return these to the AEMC.

However, we note that survey responses were due after the draft determination was released so it is unclear if and how survey input has been incorporated into the draft determination. We would like to better understand and see how the AEMC will incorporate these survey results into the final determination.

The CEC notes there is limited quantitative analysis in the draft determination to support the AEMC’s position. As an example, in addition to a limited analysis of the MLF risk premium, we note that the draft determination focuses on the MLF versus average loss factor (ALF) implications for generators. It does not recognise that large users also have an MLF. As such, no analysis has been provided of this. In assessing consumer implications, that there is limited analysis of the direct implications to loads seems to be an oversight.

The CEC engaged Baringa Partners to provide analysis to support our earlier submission around the different objectives for a transmission loss factors framework, different methodologies and quantitative implications. We appreciate that quantitative analysis can be difficult and we intended for the Baringa work to be added to the discussion about the most effective alternative to the current regime and to a robust analysis of the tensions between different loss factor objectives. However, it has been unfairly dismissed by the AEMC as stylised. The Baringa report also acknowledged that its work did not delve into the impacts of a revised methodology on cost of capital. As a result, its modelled wholesale price reduction could be even more significant in the long term, once the effects of reduced cost of capital and increased renewables investment are factored in.

It is crucial that a decision on an issue as important as transmission loss factors is supported by robust quantitative analysis to justify the AEMC’s assessment that not just ALFs but any change to the MLF framework would not meet the NEO. The CEC and our members are willing to assist the AEMC with a fuller quantitative analysis.

As a final remark, the CEC wishes to comment on the draft determination’s statement about the AEMC’s coordination of generation and transmission investment (COGATI) review. The AEMC concludes that the COGATI review provides the most appropriate forum for stakeholders to engage in discussing and assessing potential reforms that may be able to provide a long-term solution to their concerns regarding the transmission loss factor framework.

This statement does not acknowledge the substantial concerns raised by different stakeholders in relation to the COGATI proposal, which has since been recognised in the COAG Energy Council communique’s statement that the AEMC needs to engage closely with stakeholders as the COGATI work progresses over coming months.

The Australian energy market is complex. COGATI is adding additional layers of complexity through complex wholesale market reforms and a complex new hedging product. Generally, complexity can lead to bad outcomes for investors and seriously risks stalling much needed new generation investment in this country. As mentioned previously, we need to ensure an encouraging investment environment for new generation in Australia to support the energy transition underway.

Thank you again for your time and for allowing me to put forward the CEC’s views.