How does the retail electricity market work?

The current issues with supply across the NEM prompted an unprecedented response.

One point to take away from the following is that the wholesale supply of electricity has a portion which is contracted on terms over time, and the ‘spot market’ a portion which is volatile, subject to competitive pricing and a choice by generators to sell or not to sell.

We hear as consumers about the volatile spot pricing, but no one is indicating what portion of the supply at any time is subject to that volatility? As a consequence is there a tendency to exaggerate the impact to serve both the news cycle and vested interests on the supply side?

Most regulated tariffs and domestic supply from the big retailers would be based on contracted rates. With big business, this can be from their own generators so that they have a known fixed revenue stream for their subsidiary activities.

Some retailers don’t have their own generators and/or decide to buy out of the spot market (this also applies for contestable market customers) and as a result they can end up paying significantly more that the retail contracts they have entered with the customers. This is why some of the smaller retailers have advised their customers to go elsewhere as they either

  1. supply the domestic contracted rate, operate at a loss and potentially go insolvent, or
  2. review domestic contract rates causing a significant increase in the domestic rates they provide to their customers (with pool pricing being at the $300MW ceiling, the domestic rate is likely to be in the order of $0.50-0.60/kW including network, environmental and retail margins).

There isn’t an exaggeration for those on contracted terms. If the spot price remains at the ceiling, then future contract terms will be based on the ceiling price. Contract terms or regulated prices are very much dependent on the annual average spot price for electricity. This is where the impact will be on consumers whose supply is currently on a contracted supply price from the generators.

Furthermore, if a retailer can’t supply all their customers from the contracted supply agreement with their own generators, they will be purchasing shortfalls from the pool. If the pool is high, then this will be passed back (average over) their customer base.

Edit: The other main impact is the flow through on consumer goods and services. Medium to large businesses may be subject to spot pool pricing. When the pricing increases substantially for a long period, businesses where electricity is a significant cost may not be able to absorb the price increase. This means that they may increase the price of products and services which will be passed onto the consumer.

That’s a big if. The reality is the generators will need to substantiate what their reasonable costs are retrospectively for the current period. Looking forward if the system is broken, should we expect the regulator and government to accept any more than true cost plus a fair margin?

How the market works according to the Regulator. At least up until the start of 2021.

As you suggest higher electricity prices feed through in so many ways. It’s interesting to point out that wholesale prices for generation in 2020 were typically half what they had been in the preceding 4 years. If wholesale prices are expected to double or worse, how can the cost to consumers be any greater than what we were asked to pay 3-5 years ago? It’s not saying consumers will not be asked to pay more. It’s asking what will be a reasonable expectation of any future increase as measured at the household meter box and not at the point of generation 10%, 20% or something higher?

Given renewables have not increased in cost, Vic brown coal generation has not increased in cost, and not all black coal generation is facing increased cost of fuel. It would seem unreasonable to expect to pay all of these a windfall profit for no extra costs, because the smaller portion of the generators utilising gas or those with coal supply issues are paying a premium for their fuel.

1 Like

Supply and demand. With some generators off line and others unwilling to generate because the $300MW cap was less than their costs, it caused a situation where demand exceed supply. This was also contributed by the highest winter demand in states like Qld due to cooler than expected weather conditions.

Possibly correct at this point in time.

It is worth noting the cost of renewables to support the network will increase over time. While they may be cheapest form of electricity now, being ‘cheap’ is their generation shortfalls are made up by fossil fuel generation. As more fossil fuel is replaced by renewables, the trigger prices renewables will enter the market will also increase (capacity will far exceed demand and with fixed costs, the cost base will be spread over less generation).

It will bit like the current gas situation where some gas generators didn’t want to generate at a loss at the $300MW cap. Likewise, at certain times when renewable generation is high, spot market price may be lower than the cost if generation. Renewable generators will enter ir leave the market based in price. To cover intermittency of renewable generation, capacity will be significantly greater than peak demand. When I worked in the industry, some if the planners were talking about 2-3 time or more peak demand. This is required to try an meet generation shortfalls…such as wind generators stationary in parts of the country due to weather conditions. There is a point where marginal increase in generation to improve reliability exceeds storage (storage for medium term supply is very expensive and will remain expensive for many forms of storage).

It is frustrating for those in the industry to have spin doctors and vested interest parties saying when Australia moves to full renewables, electricity will be cheaper. This is incorrect and assumes the status quo where reliability issues of renewables is supported by fossil fuels will be the same in the future. It won’t and prices will increase and the cheapness if renewables will disappear except possibly in the most reliable renewable generators - which are limited and have limited opportunities.

The best response to your points is not a difference of opinion, but a reference to some not so light bedtime reading. Chapter at a time , the AER has yet to provide it’s 2022 update, which will reflect on 2021.

A slightly shorter version and more recent.

The cost of energy provided directly from renewables will remain the same or even decrease as the technology continues to mature.

It does not necessarily follow that the final cost of energy will increase. The failures to invest irrespective of technology are fundamental. It’s a complex equation as you suggest that adds short and long term storage to the base cost of supply from renewables. The decision to be renewable or not has been made. If it had been acted on as the majority of Australian’s have been asking for we would not be in the current situation of supply uncertainty and increasing prices.

The elephant in the room is that any short fall today of supply in Australia has been ten years in the making. It’s a failure of the most recent years of government and the poor choices made in those years. We are as consumers victims of those poor political decisions over that time.

Unfortunately for most consumers the retail market of the prior decade is now working to our detriment, rather than out benefit. The cost of producing natural gas in Australia has not increased nor has the cost of producing coal. That the cost of producing electricity should now have increased defies common sense. The market no longer serves Australian consumers. It’s zero to do with renewables increasing or decreasing in cost and all to do with a failure over the previous decade to invest in the future.

1 Like

That statement isn’t correct.

It is agreed In recent years the capital cost of renewables has decreased. Capital cost decreasing doesn’t reflect the costs of generation to the market to meet demand and provide reliable supply.

If a renewable generator was reliable and was running at generation capacity, then price a renewable generator is willing to enter the market would be lower than is currently the case.

Unfortunately renewables aren’t reliable nor will be running at capacity all the time in the future. To improve reliability of supply within the market, as outlined above, there will ge considerable generation overcapacity supported by storage. Storage will become an option when the marginal cost storage is cheaper than additional cost of renewable generation to support the network.

It is likely that multiples of demand on the network will be needed to try and flatten out the intermittent nature of renewable generation. Renewable generation also needs to be dispersed widely as many forms of renewables are affected by weather conditions (e.g. solar, wind and hydro).

As indicated above, the cost base for generation will increase greater than exists for renewables at this point of time. This translates to a higher cost base per unit of demand. This will increase electricity prices as the closer to 100% is attained.

I originally thought like you and media reports/political spin that renewables would result in cheaper electricity. A planner in the electricity industry explained it to me in a way which made sense and showed a differing view. Her explanation was something like…

Lets assume cars in the past were near 100% reliable (traditional generation). Imagine if cars from tomorrow were 50% reliable (renewables) - 50% of the time working, 50% not. New cars were half the price of an old cars. You would need at least two cars to ensure you could drive at any time (incorrect assumption which I will discuss further below). The running costs of each new car would double, with each car only covering half the distance travelled. The cost per kilometre travelled would remain roughly the same.

Reliability is a probability that it will work as needed. So two cars only really gives a average reliability of 75% (50% for first car plus 50% of 50% for the second car). So you need more than two cars. Lets assume 4 cars and you are accepting of a 93.75% reliability (say the remainder 6.25% it is cheaper to catch a taxi (storage) than buy another car). The running costs of the new cars would be roughly 2 times that of an old car. If one drives the same number of kilometres per year (demand), the cost per kilometre travelled would double (cost to enter the market).

Assuming renewables will provide cheaper electricity assumes the status quo of reliable traditional energy or replacements will be support less reliable renewables (this support is shown in the graphs you presented above, which show fossil fuel generation variable to meet shortfalls in renewables). While storage will fill some if the gap, it is very expensive for medium to long term supply and will only be used to push reliability from high 90%s to close to 100%.

There is also opportunity for hydrogen to offset some if the higher trigger prices to enter the market. Hydrogen has in some respects, the ability to lower this price in times of overcapacity, hydrogen can be produced as an additional revenue stream/use of excess electricity. Unfortunately hydrogen production is inefficient and won’t fully offset the additional costs.

Unfortunately there is a lot of misinformation about costs to transition to renewables.

It is however promising that Commonwealth and State Energy Ministers have indicated that discussions in the future will focus on capacity, which is needed to ensure the community understands what is required for long term development of a reliable electricity supply. It is also refreshing that discussions on transmission has has started to occur - which is needed to connect dispersed future generation around the country.

Edit: cost of generation presented in the media or by some pollies/vested interest groups is based on planned maximum generation at a particular location. Planned maximum generation capacity is very different to generation required to support a reliable network supply as indicated in the rest of this post.

Edit 2: The other consideration for future costs of renewable generation is that currently the lowest cost renewables are being developed (lowest hanging fruit). These are generators which are in more optimum locations (such as on average windier locations and/or close to connections to grid). As more and more renewables are developed, these will be less cost efficient than those which have developed in the past and also potentially less reliable (such as developing in less windy locations). Along with reliability issues, these will also push up the average renewable costs which will be reflected in the prices a generator will be willing to enter the market.

The car example is overly simplified as it doesn’t consider location, efficiencies or temporal costs which can impact on renewable generation. It however shows broadly in possibly an easy to understand way the challenges Australia faces in the future in relation to reliability and cost of electricity.

I have a question for the knowledgeable.

We are told that one of the contributing factors to the east coast power problem is the price of coal due to the international situation. When the cost got too high some generators stopped offering supply and had to be directed to maintain supply by the AEMO, which the public will ultimately have to pay for.

The question is, how is it that the coal-fired generators are vulnerable to short term fluctuations in coal prices? Why do they not have local supply contracts that ensure supply for years in advance regardless of international spot prices?

2 Likes

Most do. I suspect there will be some power stations which may have underestimated usage and buying excess on the spot market. This could be the case if AEMO requests additional generation to support the network from power stations who would not normally supply at the additional requested generation levels.

1 Like

You may well be right. This subject is a complex one and we are not served well by media who don’t ask these questions or edit the detail out to keep articles short. So unless you are willing and able to do a lot of research you end up not really understanding what is going on. This allows people to push political barrows and not be pulled up on misleading claims.

1 Like

You are 100% correct. It is extremely complex and the planners I used to chat to when in the industry were developing complex models to look at future generation and impacts on the network…and reliability. So that planning for future network needs could occur. The media has dumbed down the message so much it has lost reality. Party politics hasn’t helped either.

Hopefully if announcements from the latest Energy Minister meetings are correct, Australia might be starting to head down the right path with the discussions and decisions we need to have. It won’t come easy or cheaply (costs which could have been spread over 2 or so decades, will now be over 8 years by current reports), but it is long overdue.

Edit: Hopefully the media starts asking some of the hard questions such as

  • to achieve 100% renewable generation targets in Australia, how will less cost efficient generators and increased intermittency of generation be dealt with such that existing network reliability standard are achieved in the long term (namely, electricity available when one plans to use it)?
  • with a forecast substantial grown in demand as Australia moved from fossil fuels to renewable electricity as its main energy source, how will Australia meet this future demand?
  • what will be the cost for consumers?

The answers need to be definite rather than spin type answers such as ‘renewables will be cheaper’ or ‘Australia don’t have any issues as it has abundant potential renewable resources to exploit’. These are political spin and don’t address the challenges Australia faces.

2 Likes

They do, as @phb also responded.
The contracts can include a number of options for how pricing changes with supply. ‘Take or pay’, escalation and market adjustments are all possibilities. The majority of coal produced is sold on contract. We would need to see the details of what are confidential contracts to be confident a particular opinion or statement can be relied upon.

The spot market price is misleading if used as an indicator of the average price being used to determine the cost of supply to the generators. NSW in particular has had issues with supply due to weather events and availability of lower cost (compared to gas) coal generating capacity across the NEM.
Energy markets tipped to return to normal as NSW granted emergency powers to secure coal supplies | Australia news | The Guardian

The politics and media aside, the AEMC, etc has as previously linked a great wealth of published content, both on current performance as well as future planning. It’s all publicly accessible. The one uncertainty is the planning in place assumes the status quo. There is no judgement on the political decision to move forward with a free market driven by private investment vs state ownership.

3 Likes

Ref the AEMC - strategic direction.

From the content available from the AEMC web resources, the following is a most digestible (info graphic summaries - 6 pages in pictures with notes) current document media released by government in July 2021. It anticipated the possibility of increasing problems with supply due to unreliability of coal generation and price shocks within the market.

How the changes proposed will be implemented and consumers impacted - remain decisions for the Energy Ministers and their respective governments to agree.

1 Like

Answering a totally different question about coal-fired generators … one problem that Australia has is a 15 year failure by government to provide bipartisan support for a regulatory environment that gives certainty.

These types of investments, whether fossil or renewable, are typically predicated on a long term business case i.e. high up-front cost in the early years but eventually breaking even and beyond that eventually giving an adequate return-on-investment.

If you don’t know what the regulatory environment is going to be in 3 years time, much less for the needed lifetime of your investment, you may choose not to invest. (To some extent, regulatory uncertainty always exists i.e. sovereign risk, but it can be made higher or lower.)

So, coming back to coal-fired generators, if you are looking at having to spend zillions of dollars on preventative maintenance that won’t pay back for 10 years and you aren’t even sure whether or under what conditions you will be able to operate by the end of those 10 years, you might choose to run the asset down.

So for the last 15 years we have created regulatory uncertainty for fossil fuel generators but without building the renewable alternatives.

1 Like

A picture is worth more than ……

Monday morning on a typical winter day, and as usual there is an apparent lack of capacity in NSW to provide generation sees it importing power across the national grid from SA, QLD and Vic? One could also assume that it is cheaper than bringing on more expensive NSW based gas fired generation to meet the peak.

The Orange circles on the power flows out of QLD indicate those feeders are at capacity.

The dollar values are the spot prices for generation in each state at that time. When one state is short generation in the NEM it tends to drive the spot market higher. This affects more than just the state with the shortfall in capacity. Any increased demand in the other states is subsequently priced against the higher pricing in place to meet (in this instance NSW) the shortfalls elsewhere.

A significant highlight this morning is Tasmania is not participating and exporting any hydro surplus. Note how much lower the spot price is compared to the other states generators.

P.S.
I’m not picking on NSW as having failed to construct adequate new generation capacity. It just looks that way. NSW has announced several major projects to add significant capacity through renewables and storage. The states have an equal hand in todays circumstances, for better or worse, richer or poorer.

2 Likes

No it doesn’t. Looking at spot prices has no relationship to whether there is enough free generation capacity. Spot prices reflect the price at a particular point in time.

The chart you have shown only shows where generation is occurring, what the demand is and also the spot price at that specific point in time.

AEMO’s role is to ensure that that is enough generation on the main grid to support the demand on the network. The figure shows that this is the case and that there is flow over the interconnectors to achieve this outcome. The possible reason there is flow from QLD to NSW on the morning in question is that AEMO forecast negative spot prices in Queensland later in the day…see…

It makes sense for AEMO to move cheap electricity from QLD to NSW to satisfy NSW demand, especially when cost to increase NSW generation to cover this demand is more than that from QLD. If this wasn’t done, the price in NSW would be higher - against the interests of electricity users.

1 Like

@phb I think you may have missed some of what @mark_m noted. Demand influences price and what I think @mark_m was saying is as that the spot price was high due to demand but not so high because

When and if NSW brings in cheaper production (renewables and storage playing a large part) prices would come down as demand is met from cheaper supply sources rather than higher priced sources. Of course FF suppliers currently benefit from a lot of support and it appears low taxes, I think they would be working hard to maintain their cash cows and talking down renewables. Even the Fed Govt are talking about a huge amount of support to FF production to maintain supply on top of the already rich returns these companies get.

1 Like

While that is correct about demand impacting on spot prices, I was addressing the (political) comment that this is because NSW has insufficient generation capacity because the government failed to have adequate generation capacity. This deduction isn’t correct as indicated in the above response. The main grid is interconnected and AEMO manages generation and flows to meet the demand. It can chose not to engage a generator at one location for many reasons, including to ensure prices are minimised. As the main grid is interconnected, flows from any generator can be used to support the network and demand in Tasmania, Vic, SA, NSW, ACT and Qld. In the future flows across interconnectors will increase to try and stabilise the intermittency of renewable generation. This has been discussed recently by the Energy Ministers and for some time within the industry.

The NSW Govt in 2015 admitted they only produce 90% of their internal demand. In 2021 the Liddell report indicated by 2023 the shortfall in NSW would be about 154MW (these are figures supplied by AEMO).

The NSW Govt is trying to boost production by creating projects but most of the answers are couched in terms of “may”…there is no certainty to these. Therefore the NSW electricity grid is currently and into the near to medium future, reliant on other energy producers outside the State to currently meet the shortfall. The previous LNP Fed Govt wanted more private power generation to be built to cover a future 1000MW Generation need and this was promoted via a Fed funded Gas fired generator if the private sector didn’t step in. The Gas fired generator became a more real thing when under Scott Morrison’s Prime Ministership the Kurri Kurri Gas Generator in the Hunter region was announced.

The ESB and others are concerned that the cheap spot prices achievable by using Renewables will impact the decision by Fossil Fuel run generator generation companies to close their plants as they become unviable at the lower prices. This is a problem when there is no other way to overcome a shortfall in the short to medium term and thus the current discussion about offering FF run generation to be subsidised to keep them viable until replacement generation comes online.

Most of this shows a lack of support by multiple Govts for the past many years, of alternative energy production and storage of that energy. If decent investment had been made much of the need to pay large spot pricing would have been ameliorated. Even the ESB, AEMO, and AER admit that this is so. What do they propose as an answer…further investment in Coal, Gas as well as other forms of dispatchable energy production to be built. Still we hang onto the FF teat of energy production.

Political, sure it is; energy production is a profit making and a profit taking business. While corporations that are heavily invested in FF profit generation, not talking about energy production here (it is just the means to an end) but instead the need to create profits for their shareholders, we will continue to see that they will lobby hard to get the best profit for their shareholders that they can reap from the income sources.

2 Likes

Only at that time to the benefit of users in NSW.

@grahroll has made reference concerning the lack of investment in generation and reasons for.

Despite there being a single NEM it is far from being unified.

The NEM is a hydra with multiple layers of regulatory bodies and interdependence along state lines. The ACT operates it’s own market. QLD has retained state ownership of all distribution and a large portion of generation. Tasmania has fully retained ownership of generation and distribution. The other states all have varying degrees of interest in the assets. SA elected to go down it’s own path first with wind power followed by the Hornsdale Tesla battery project. The NSW Govt is now backing in financially significant investment in developing renewables.

For regulated pricing Victoria does it’s own thing, Qld has a split personality with the State regulating prices outside the SE offsetting higher regional costs against income from the SE corner. Tasmania has in recent years even considered walking away from the NEM.

I doubt it’s possible to look to how the NEM was created, has evolved, and is now functioning (or not) without acknowledging the decisions made along the way. It is in every way a political outcome.

The Guardian offered this alternate view on the way forward.

1 Like

Yes, but it is only an issue if the network isn’t interconnected. The grid is no longer state-centric and the states influence which peaked about two decades ago is likely to diminish over time. The Guardian alludes to this.

The point being made above was due to generation totals, flows at spot prices at the time in question, it somehow was attributed to the NSW government failure to invest in capacity. If NSW must be self sufficient in capacity, why have interconnectors. And Qld, Vic, Tas, ACT and SA must all be the same boat as NSW as at other times flows on the network are from other states to these states.

The main grid is interconnected. These interconnections will become more important as Australia moves towards higher percentage of renewables…as I indicated on a number of times to address in part the intermittent nature of renewable generation. In the future the capacity of these interconnectors will increase to allow greater flows between states.

Flows between states isn’t a rivalry like the State if Origin where there must be a winner or loser depending on the score. The management of flows and generators by AEMO is about meeting demand and reducing prices. If NSW has a deficit in generation, it can rely on generation capacity elsewhere for support.

Spot price is irrelevant to generation capacity. BTW, Australia has sufficient generation capacity across the whole of the main grid. Some may argue differently based on recent events, but these events were about availability (planned outages, unplanned outages and price driven generation entry to support the grid) and not capacity. It is possibly a wake up call as availability risks will increase in the future as more renewables replace traditional generation. This has also been discussed by the Energy Ministers a few weeks ago.

In relation to SA, it is worth reading why the EnergyConnect project is needed as a matter of priority. It is also worth noting that SA is supporting its local grid deficiencies through diesel and gas powered generation. Local capacity and interconnector capacity limitations is struggling to meet demand…hence EnergyConnect.

There as been talk about WA and NT joining the main grid for some of the reasons outlined above. It will happen, but when will be the question.

Tasmania can’t walk away from NEM as it relies on inflows there has been political postering arguing otherwise without realisation of what it means. Basslink II will be needed in the future when forecast demand is set to double what it would have otherwise been the case through to transition to electricity as the primary energy source. There is discussion locally why Tas should be paying for half if Basslink II when currently it would only enjoy about 6% of the benefit.

1 Like