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Australia’s Grid Is Being Cornered by Its Own Generators

Australia’s Grid Is Being Cornered by Its Own Generators

Friday, 17 June, 2022 - 05:15

In commodity markets, there are few phenomena more feared than a corner.


If a few traders become too dominant, they can at times set prices at will by withholding supply, driving values to ridiculous levels. That’s what happened when the Hunt brothers cornered the market in silver in 1980, sending it to prices that are still a record. In equity markets, short squeezes like the one that caused Volkswagen AG to briefly become the world’s most valuable company in 2008 also represent a sort of corner.


That situation has been playing out this week in the market underpinning Australia’s main electricity grid. Regulators were forced Wednesday to suspend the spot market into which generators sell power, saying that trading was getting in the way of ensuring secure and reliable electricity supplies. That will temporarily switch the network from one run on capitalist principles of supply and demand, to something like a planned economy where the regulator directs utilities what to do.


It’s an extraordinary failure, especially considering that there’s no shortage of generation capacity out there. The best explanation is that the cornerstone players in Australia’s power market have seen the business model of their coal-fired assets incinerated. They decided YOLO, and chose to make a play for some short-term cash, rather than long-term stability.


Australia’s power market operates as a series of rolling reverse auctions. Generators bid to sell electricity into five-minute windows, with the price they all receive set by the highest-cost player. For wind and solar, those costs are effectively zero. Coal is relatively cheap too, so the marginal generator who sets the market price is typically gas-fired.


That’s the start of the problem. As the world’s largest LNG exporter, Australia’s gas tends to move in line with global prices that have soared thanks to the invasion of Ukraine. Russian exports of pipeline gas to Europe have declined by about a third over the past month, pushing up the cost of wholesale electricity in Australia to the point where it triggered government price caps.


In theory, the regulator can then direct generators to switch on and sell power into the market, but that’s not happening. Coal-fired power stations, which still account for about two-thirds of Australia’s power mix, have been absent. About a third of coal-burning capacity was offline during Wednesday’s evening peak, despite pricing that should guarantee hefty profits for every generator who sparks up.


What’s going on? The generators point to an unfortunate series of coincidences. Some units are down for scheduled maintenance. Others have been taken offline unexpectedly — a failed inverter or parts shortage here, some damaged boiler equipment there. Shortages of coal may also be playing a role.


At the same time, in Australia’s highly concentrated power market, those who leave some of their generators cold a little longer end up getting far higher prices for the units still running. Consumers and businesses end up cornered, and pay the price. “We have these dominant players who are actively withholding capacity from the market when we need it,” said David Byrne, a professor of energy market economics at the University of Melbourne. “They are enjoying very high prices in these extreme conditions.”


Carl Kitchen, a spokesman for the Australian Energy Council, the association for generators, rejected those claims and said workers had been doing their best to get plants back online. Three units with combined capacity of 1,200 megawatts have been brought back online in the past 24 hours, he added.


One constraint on market corners is typically that participants have an interest in their long-term standing, which encourages them to behave. That’s changing in Australia’s grid, however, as it transitions from its current roughly 75% fossil fuel-fired electricity network, toward the new Labor government’s target of 82% renewables by 2030.


“Some of them are feeling ‘We’re on the way out, let’s get as much as we possibly can,’ and that frames their approach to the market overall,” said Bruce Mountain, director of the Victoria Energy Policy Center in Melbourne. “It becomes possible to get away with blue murder.”


In one sense, what’s happened has been a technical failure of market design, much like the circumstances that allowed 2021’s meme-stock frenzy to flourish and those which briefly drove nickel prices up five-fold on the London Metal Exchange earlier this year.


In another, even the most free-market power grid is ultimately governed by politics. This week’s disruption was a “game of chicken” between generators and the regulator, said Byrne. The likeliest short-term solution may well be for Australia’s Labor prime minister to get on the phone to the Labor premier of Queensland state, and encourage state-owned utility CS Energy — currently the worst offender, with just 30% of its coal capacity online during Wednesday’s peak — to start supplying more power.


Private-sector coal generators should do the same and start behaving not like commodity traders taking advantage of market disruptions, but suppliers of essential infrastructure to the nation. Australia’s coal fleet is dying — but like a wounded animal, that’s when it’s at its most dangerous.


Bloomberg


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