Trends in Wholesale Electricity Prices in Victoria PRESENTATION TO AIE’S ENERGY PRICING IN VICTORIA: TRENDS, CAUSES AND THE

FUTURE, 25 JUNE 2014

Discussion points

1. Focus is on wholesale market

2. Discussion to cover:

• Historical review • Fundamental drivers of price setting • Outlook for electricity prices in Victoria

Background

1. NEM commenced operation as a “national” market in December 1998

2. Evolved out of the combined NSW/Victoria pool market linking the SA market into these two markets.

• Vic Pool operating since 1992 3. Queensland became integrated in 2001 with commissioning of Eastlink and

Tasmania in 2006 with commissioning of Basslink.

4. Now fully integrated market

Price History

• Prices have moved up and down reflecting broad energy policy changes, temporary supply constraints, adverse weather.

– In other words, have reacted to changing supply/demand conditions. • Prices across the States converged especially after interconnection capacity was

enhanced

• Prices are currently at the lowest level in real terms since the combined national market commenced operation

– Prices have recently increased in some states (e.g. Queensland, Victoria) due to capacity withdrawals

• Increased in mid 2012 as a result of the commencement of carbon pricing

– Around $20 to $25/MWh contribution from carbon pricing

Price History

0

10

20

30

40

50

60

70

80

90

May-95Nov-95May-96Nov-96May-97Nov-97May-98Nov-98May-99Nov-99May-00Nov-00May-01Nov-01May-02Nov-02May-03Nov-03May-04Nov-04May-05Nov-05May-06Nov-06May-07Nov-07May-08Nov-08May-09Nov-09May-10Nov-10May-11Nov-11May-12Nov-12May-13Nov-13May-14

$/MW

h

Quarter Ending

Real Regional 52 Week Pool Price ($June 2013)

Vic NSW Qld SA Tas

Separate State Markets

NEM 1

NEM 3

QNI

Basslink

Drought

Renewables and GFC

Carbon Price

Price History

0

10

20

30

40

50

60

70

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

$/M

Wh

Financial Year ending June

Vic Spot Price June 2013 dollars

Factors Affecting Recent Price Trends • Demand has shown steady declining trend since 2009

– Energy efficiency – Reaction to high retail prices – Industry restructuring – Small scale renewable energy generation

• Milder winter and summers

• Large scale renewable energy generation

• Some of these factors will change putting upward pressure on prices

– Rising fuel prices (legacy contracts expire) – Capacity withdrawals – Limited strategic bidding

• Basically market is responding to supply/demand balances

Price Volatility

• Level of volatility is an important indicator of market health

– Price spikes or increasing incidence of price spikes is an important signal for new investment. It is a key feature of price only markets.

– But high incidence of price spikes could also be an indicator of market power • Level of volatility has been up and down!

– Has been a lower level of incidence in most States (since late 2010) – But in some smaller States constrained by interconnect capacity incidence

has been at trend levels – Also a cyclical pattern to spikes, with increased incidence during summer

and mid year in peak demand periods and/or contract renewals

Price Volatility

0

20

40

60

80

100

120

140

160

180

200Ju

l-94

Jan-

95Ju

l-95

Jan-

96Ju

l-96

Jan-

97Ju

l-97

Jan-

98Ju

l-98

Jan-

99Ju

l-99

Jan-

00Ju

l-00

Jan-

01Ju

l-01

Jan-

02Ju

l-02

Jan-

03Ju

l-03

Jan-

04Ju

l-04

Jan-

05Ju

l-05

Jan-

06Ju

l-06

Jan-

07Ju

l-07

Jan-

08Ju

l-08

Jan-

09Ju

l-09

Jan-

10Ju

l-10

Jan-

11Ju

l-11

Jan-

12Ju

l-12

Jan-

13Ju

l-13

Jan-

14Ju

l-14

$/M

Wh

Real Victorian Pool Price ($Jun 13)Real SMP Quarterly Annual

Price Volatility

• Conditions for price volatility

– Recent increase in reserve margin has dampened volatility – Only during temporary tight supply/demand balance periods (last summer) – Some instances of temporary price spikes in off-peak periods – Induced price volatility during contract renewal periods to maximise contract

premiums – But retailers have responded to historical price spikes by building their own

peaking capacity

Level of Competition

• Generally the spot market has been competitive

– Interregional networks have been unconstrained 95% of the dispatch intervals so not allowing for may periods of price separation.

– Very few instances of yearly moving average prices going above new entry levels

• There have been some instances of strategic bidding

– Difficult to determine whether this is due generators using their market power – Or bidding to maintain reasonable profits

• But increasing levels of horizontal and vertical integration

– Increasing vertical integration probably not yet reached level to be a problem – Barriers or costs for new entrants becoming high

• Vic market not as prone to strategic bidding

Incidence of Price Separation: Vic/SA

-100

0

100

200

300

400

500

600

0 100 200 300 400 500 600

SA Pr

ice, $

/MWh

Vic Price, $/MWh

Price fundamentals

• Electricity markets exhibit a mean reversion characteristic

– In the long run prices converge to the long run marginal cost of new entry – In the short term, prices deviate to short time supply demand conditions

• Most State markets exhibit a supply (bid) curve that is relatively low for a high portion of capacity and then a sharp rise in marginal costs for small portion of capacity

– This is adjusting slowly over time as more shoulder/peaking plant enter the market

– But affected by other factors such as renewable energy support policy

Price fundamentals

$/MWh

MW

Off-peak Demand

Average Demand

Peak Demand

Price fundamentals

$/MWh

MW

Off-peak Demand

Average Demand

Peak Demand

Outlook for Price

• Uncertain times ahead

• Drivers of price trends

– Policy developments – Demand trends – Capital costs – Fuel prices – Strategic decisions

Policy

• Carbon mitigation policy

– Carbon price likely to be repealed – Replaced by ERF

• Energy efficiency • Some low emission generation

– What will occur in the long term • Some form of carbon pricing reintroduced? • Indirect action • Investor response

• Renewable energy policy

– Current review – Target reduction

• Even a reduced target (real 20%) will likely see around 2,000 to 3,000 MW of additional renewables

– Other support policy (CEFC, ARENA)

Demand trends

• AEMO’s latest forecasts indicate subdued demand growth

– Substantial reductions from last year – Large industrial loads leaving

• Uncertainties in demand

– Ongoing operation of other large loads – Small-scale generation uptake – Energy efficiency

• Some wind back of government policy • But more attention being paid to energy efficiency by large scale

enterprises

Demand trends- AEMO Projections

Demand trends – PV uptake

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034

MW

Capital costs

• Prime determinant of long run marginal costs

• Historical long term decline but with major cycles

• Latest costs are higher than long term historical trends

– Cyclical and/or structural – Differences in cost trends across technologies

Capital costs

0

50

100

150

200

250

300

350

400

450

500

550 19

92

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Gas

turb

ine

FOB

cos

t, $/

kW $

2013

AUD/kW real USD/kW real

Capital costs

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2,200

2,400

2,600

2,800

3,000

3,200

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Gas t

urbine

FOB c

ost, $

/kW $

2013

Brown Black CCGT Black Brown CCGT CCGT (USD)

1992 SKM study for Cth Govt and ESAA

Stanwell Millmerran Kogan Ck

* Productivity growth* Modularisation (offsite construction)* Use of low cost country materials and fabrication* Low global demand for new-build coal plants

* GFC* Rising AUD

* Mining and energy boom

Strategic decisions – Vic SMP Projection – 41 TWh LRET

0

5

10

15

20

25

30

35

40

45

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

$/M

Wh

Conclusions

• Outlook uncertain

• Conflicting trends

– Main uncertainties revolve around policy developments and demand trends • But prices should eventually rise to LRMC levels

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Trends in Wholesale Electricity Prices in Victoria

PRESENTATION TO AIE’S ENERGY PRICING IN VICTORIA: TRENDS, CAUSES AND THE FUTURE, 25 JUNE 2014