Australian electricity - paying for capacity

The recent power crisis, together with a new ALP government in Canberra, has given fresh impetus to adding a capacity payment mechanism to the National Energy Market (NEM) – the single grid that links generating capacity across the entire eastern seaboard plus South Australia and Tasmania.

Energy Only system

At present the NEM only pays generators for power actually delivered into the grid – an energy only model (EOM). The system operator (AEMO) runs an auction every 30 minutes for the supply of enough power to meet expected demand – the lowest bids win the right to supply the market. The reported crisis in recent times was in part a function of both reduced generating capacity from the coal fleet (both planned and unplanned) as well as high coal and gas prices driving up the breakeven price for this supply. The underlying logic of an EOM is that periodic periods of high prices provide incentives for adequate maintenance, plant upgrades and in the long term for new capacity. The payback, however, for any new investment only occurs when the generating asset actually supplies power into the grid.

Payment for capacity

Amongst the political posturing about who and what is responsible for the recent power “crisis”, the Labor government has announced its support (1) for a capacity mechanism that pays for generation and storage assets that are on standby and ready to support the grid. In other words there is a payment for being “locked and loaded” even if no actual electrons are dispatched into the grid. This is being characterised by some commentators as a form of insurance. It could perhaps be more accurately described as an incentive to invest in both generating and especially storage assets which may only be used periodically when other presumably lower cost assets are unable to meet demand. In this context it is worth noting that the NEM and Australia more broadly has no last resort ability to import power from neighbouring countries so if for whatever reason supply can not be met someone will need to go without electricity

Interestingly, JTZC discussed energy only and capacity markets several years ago when examining a power supply “crisis” in Texas which was catalysed by extreme weather and the resulting failure of a range of generating assets (2). Texas, like the NEM, does not have a capacity market.

Opposition to a capacity market

Recent opposition to adding a capacity market component to the NEM has downplayed its potential to promote more storage and has been focussed on how it will be applied to prop up existing fossil fuel generating assets. It was opposed by climate activists who accused the previous LNP government of floating the idea as a backdoor strategy to keep the existing coal fleet running. The argument is that payments to aging coal plants will help them to stay online when climate and economic pressures should be forcing them to be replaced by low cost wind and solar. In other words opponents are concerned the capacity payment will become a de facto subsidy for fossil fuel generators siphoning off funds and slowing the transition to wind, solar and storage.

While criticism of a capacity market has been more muted in recent times given the change of government and a desire to be seen as finding solutions, there is still strong opposition from the Greens and other fellow travelers to any support going to coal or gas plants (3). More pragmatic voices such as the NSW government and Alan Finkel (4), former Chief Scientist and author of the 2019 Finkel report into the energy markets are happy to exclude coal but want fast acting gas plants to be eligible. Others, such as the CEO of Alinta Energy, owner of the coal fired Loy Yang A plant in Victoria as well as a number of gas plants around Australia has not unsurprisingly mounted an argument for both coal and gas to be included in any new capacity scheme (5).

Storage needs a capacity market

Hopefully without the distortion of an imminent federal election, a rational discussion will take place as it seems to JTZC that a capacity mechanism should be considered as an important catalyst for greater investment in power storage.

Under the current energy only system anyone considering investing in a standalone storage facility needs to estimate both the cost of buying power during periods of ample supply (sun is shining and the wind is blowing) as well as the likely price they will get for discharging this power back into the grid at a later date when supply is weak and pricing hopefully higher. This buy low, sell high opportunity might seem attractive on paper, but a cautious investor or indeed a bank lending to such an investor might see too much risk. Providing a guaranteed minimum annual revenue via a capacity payment will potentially make a huge change to the risk calculation.

To be fair, it is likely that short term storage, including household battery systems intended to allow daytime solar to be used at night, could probably be funded and built with an energy only model. If, however, the grid operator values the security of battery systems that aren’t being discharged every evening and can be relied upon to support the grid if front line generators aren’t available as was recently the case they will need to pay for this investment.

Long term storage – pumped hydro or gas?

As has been discussed previously in JTZC (6), the achilles heel of a wind and solar based grid will be the few weeks each year when output from wind and solar generators can not meet supply. During these periods short term storage will be exhausted after 2-3 days and without dedicated long term storage or emergency generating capacity supply will not be able to meet demand.

A recent study by the Grattan Institute (7) suggests that ensuring supply security is potentially not too hard (in relative terms) as wind and solar generation is increased up to about 70%. Even at these high levels, short term storage and residual gas plants should be able to cover the expected winter supply drought. As renewables exceed this level, however, maintaining supply security will become more problematic.

Australia has two options for managing supply when wind and solar generation approaches and potentially exceeds 90%. These are either a network of pumped hydro facilities or a dedicated backup gas fleet – or some combination of the two. Both of these options will require investment that will simultaneously be absolutely vital and underutilised.

Some may feel that a critical national back up electricity supply system should be government owned and operated, like the original Snowy and Snowy 2.0. Perhaps this model will be adopted and if so the required capacity payment will come from taxpayers. If, on the other hand, some part of the system is privately funded or owned (as seems inevitable given recent government preference) there will need to be formal compensation for dispatchability with significant penalties for non performance. Whatever operating model evenuates, someone will need to guarantee that pumped hydro dams are full and the gas turbines are well maintained and ready to go.

The choice between pumped hydro and gas will be interesting. If the overriding goal is to get to 100% low carbon generation then the choice has to be pumped hydro. In which case determining the capacity of the system will be tricky. The capacity of a back up pumped hydro network is determined by the maximum volume of water able to be stored when dams are full. Large scale pumped hydro has a significant physical footprint and will inevitably face local opposition from those in favor of decarbonisation but don’t want to have their local valley flooded. Short term political expediency will collide with long term supply security.

On the other hand, if a net zero target permits the use of a highly regulated gas fleet, there will be greater flexibility to manage an extended supply drought (assuming gas is available and plant maintenance is adequate). The obvious downside with this approach is that it locks in a small but non zero level of ongoing emissions, though optimists will point to ways in which this could be mitigated or even eliminated using

Addition of carbon capture and storage technology.
Use of carbon neutral bio diesel or gas fuels
Retrofitting the fleet to run on green hydrogen

Specifying the size of the back up system

It won’t be easy to definitively specify the required capacity for an emergency backup system that guarantees supply security. Historical wind and solar data over a decade or so might indicate a hypothetical worst case scenario of say a 15 day period when wind and solar generation will only meet 50% of expected demand. Based on a NEM demand of 0.55 TWhrs/day one might calculate that the backup system needs to be able to supply around 0.55 TWhrs/day x 50% for 15 days, which equates to about 4 TWhs or 2% of the annual NEM output. That will work out just fine until a once in 50 year event occurs and the grid needs 20 days of support or maybe even 25 days. It will be interesting to see if elected officials sign off on 15 days of storage or will demand something larger, more expensive and more likely to be deemed a white elephant.

Demand minimisation

Currently when there are calls to reduce or minimise power demand, as has been the case recently, this is seen as a “crisis” and a clear system failure. This reflects current societal expectations that power is always available even during periods of peak demand – typically in late summer after the school holidays when air conditioning is running flat out and the economy is back to normal after the Xmas break.

As Australia shifts to a renewable based generation system, one suspects this attitude will change. A supply shortfall won’t represent a system failure but an inevitable consequence of using zero carbon generation. With this mindset, as climatic conditions suggest an imminent period of low sunlight and wind, mechanisms to reduce demand will be activated. It is not clear what these future measures might be but they are likely to go beyond asking large industrial users to wind back, though that will be part of the response. As more and more households and perhaps some commercial operations install their own battery systems it is likely that consumers will be offered the opportunity to accept payment for going fully or partially “off the grid” for a week or so.

Where do we stand?

So who is right and what should we make of the vigorous debate on what a capacity mechanism should look like? The answer probably depends on what one expects to achieve from the introduction of a capacity mechanism and how one balances future climate risk against supply shortfalls.

The Greens and other climate activists clearly focus on getting to net zero as quickly as possible with a policy goal of zero carbon electricity by 2030. With this mindset, anything that might delay the closure of a coal and gas plant must be opposed. Does this mean that grid reliability is a secondary concern? Adam Bandt would say no, telling us to trust in massive amounts of low cost wind and solar. Others might not be so sure.

Alan Finkel is on the record as stating that using modern combined cycle gas plants as backup generation will actually speed up the rate at which wind and solar can be rolled out. One suspects his logic is based on a view that Australian society will not take kindly to power shortages and interruptions and if these occur there will be a very strong call for a pause and review of the transition to renewables. Given the current angst, this logic seems on the money.

Existing coal plant operators will logically want in on some of the action if capacity payments are on offer. The validity of these requests should be less influenced by ideological opposition to fossil fuel subsidies and more based on supply security within the guard rails of an agreed decarbonisation timetable. If we need some of the existing coal plants to stay online for a decade or so the choice may be between a capacity payment that combines real penalties for not being available when needed and relying on the power plant operator making enough money via EOM sales to pay for maintenance and next year’s coal supply.

If the election of the current ALP government signals the end of ideologically driven “climate wars” then perhaps we are entering a period of pragmatic action towards a decarbonised grid. This would see a capacity market that is designed around the closure timetable of existing coal and gas and encourages large scale pumped hydro storage (or some other form of long term storage). It would also see a more open and informed discussion about the inherent supply issues associated with wind and solar and how these can be overcome. Perhaps this will result in greater acceptance for gas as an emergency backup and a change in attitudes toward demand minimisation.