On 17 October, 2017 the Federal Government released its much anticipated energy policy called the National Energy Guarantee (NEG). The NEG has two components:
- The Reliability Guarantee, which requires retailers and large users to procure a certain percentage of electricity from generators that meets a certain level of dispatchable energy (from ready-to-use sources such as coal, gas, pumped hydro and batteries); and
- The Emissions Guarantee, which requires retailers and large users to procure a certain percentage of electricity from low emissions generators to meet emissions targets set by the Commonwealth Government.
The proposed policy is expected to lead to retailers procuring a significant percentage of their electricity from generators via contracts. The Energy Security Board (ESB) expects these contracts will provide revenue certainty to generators, and revenue certainty that should lead to new (lower emissions) generation investment. The increase in supply versus a flat demand outlook would in turn lead to lower wholesale prices, with the ESB estimating wholesale electricity prices could fall by 20-25% from 2020-30.
The technology-neutral approach of the policy means no more indirect subsidies to support renewables projects beyond 2020, which many expect will lead to a slowdown in renewables investment.
The next step by the Federal Government is to take this policy to the Coalition of Australian Governments (COAG) meeting in November. If endorsed, details of the policy (and key parameters) will be prepared during 2018, with the reliability guarantee to commence in 2019 and the emissions guarantee in 2020.
Our view is that the reduction in wholesale prices will depend on:
- The industry gaining confidence that this policy will remain in place long enough to justify material investment in new generation capacity; and/or
- Generation technology costs declining to make the investment more cost-effective versus contracts with existing thermal generators.
Generation capacity in the NEM, by region and fuel source, 1 January 2017
Source: Australian Energy Regulator (AEMO) (October 2017)
So will East Coast electricity prices remain elevated over the next 3 years?
We believe so for 4 key reasons:
- Higher gas prices (leading to higher gas fired generation costs)
- Hazelwood power plant closure, increasing reliance on older coal power stations and increasing gas usage
- The requirement to replace Australia's ageing coal fleet (average age 31 years)
- New supply from the Snowy Hydro and other initiatives won't be available in the medium term.
Policy appears good for ASX-listed generators
It is worth noting that the policy announced by the Government doesn't require new legislation to be passed by the Federal Government, i.e. it cannot be blocked by the Senate. On the face of it, the announcement is positive for AGL and Origin’s generation assets, most of which satisfy the Reliability Guarantee. These businesses have also developed significant operations focusing on developing their renewable energy portfolios.
We await the Labor Party's response to the Government's move away from adopting a Clean Energy Target, which was the recommendation proposed by the recent Finkel Review. Even if the policy is adopted, we anticipate some uncertainty will remain regarding the longevity of the National Energy Guarantee until beyond the next Federal Election.