Australia faces energy price surge, despite renewables

Australians face the prospect of higher energy prices if demand flexibility is not addressed urgently. Despite the accelerating shift to cheaper, renewably generated electricity, the transition from fossil fuel generation and the complex mechanisms used to set future electricity prices could mean higher bills in coming years.

Recent events have highlighted this, with dramatic surges in spot and future prices in June, when high demand for electricity due to cold weather coincided with coal-fired generator outages and low wind output.

This perfect storm led to periods of extremely high prices, in some instances reaching over $15,000/MWh. To put that in context, that is 50 times higher than the normal $300 price evening peak price — in the middle of the day the price is normally around $50.

We had two four-hour price spikes, contributing to a June average monthly price in Victoria of $264/MWh, compared to the monthly average of $76, and in South Australia of $250, compared to the average of $86 over the past five years. In NSW, it resulted in a June monthly average of $256, compared to $107.

The National Electricity Market is governed by supply and demand, setting the ‘spot price’ every five minutes. The average spot price is a critical driver of forward (exchange-traded) contract prices, and both the spot and forward contract prices drive the default market offers. These forward contracts are critical for large users who often buy their energy in advance.

The default market offer is a safety mechanism, setting a limit on the prices retailers can charge households and small businesses. It is calculated using spot and forward prices — the price charged for contracts guaranteeing future energy at a set price. So, when spot prices spike, it influences what businesses and homes pay for electricity in future years.

In the coming years, the pace of the energy transition creates potential for more price spikes, and the maximum price allowed in the spot market is set to rise. This means that price spikes may have greater impact on forward contracts and ultimately what businesses and homes pay.

The market price cap is set to increase from $20,300/MWh today to an expected $27,000 by July 2027, after accounting for expected inflation. This calculation is based on official figures from the Australian Energy Market Commission (AEMC), the chief rule maker for the energy market. As the cap increases, the impact of price spikes becomes even more pronounced.

The implications of these price surges are far-reaching. Policymakers, including Energy Minister Chris Bowen, are considering modifications to the default offer calculations. This could include changes to prevent high price spikes from disproportionately affecting future costs. The current methodology reflects forward prices from a prior period and can lead to significant increases following short-term price spikes.

To address these challenges, enhancing system flexibility is crucial. This includes increasing the volumes of flexible demand response (when large users cut back power use in times of high demand or short supply) and expanding battery storage capacity.

The just-released draft Nelson Review into the National Electricity Market (the final is due by year’s end) signalled that our price-setting system, with a short-term spot market and the longer-term future derivatives market, is here to stay but needs strengthening to cope with the mounting pressures of a more weather-dependent and energy-constrained renewable system.

It warned that consumers “may face greater price volatility and reduced predictability in their energy bills” and that “without reform, consumers will remain exposed to the full force of future fluctuations”.

The review suggested adapting the market to better accommodate volatile price shocks, while maintaining incentives for generators and suppliers. It also advocated for more energy storage and adopting flexible demand so consumers use more power at times of lower demand, at a cheaper price.

The role of fossil fuel-fired generation in setting high prices during these periods cannot be ignored. While these generators play a critical role in meeting demand, their high costs can drive prices to unsustainable levels. We must balance the desire to avoid blackouts with the goal of keeping prices affordable for consumers; the value industrial customers place on reliability has fallen in the latest survey, signalling a recognition of the tradeoff.

Policymakers must ensure that the market incentives do not inadvertently drive prices higher, raising the default market offer and impacting households and businesses.

Businesses should be carefully evaluating power purchasing agreements, solar generation and microgrids, while addressing the aspect of energy costs they can control, making their power use more efficient and more flexible.

There is an urgent need to enhance system flexibility, increase storage capacity and carefully manage the role of fossil fuel generation. With these actions Australia can stabilise electricity costs and dampen price volatility, ensuring a sustainable and affordable energy future for all.

*Lisa Zembrodt is Principal and Senior Director of Sustainability Business at Schneider Electric.

^Jasper Noort is Associate Director of Australian Energy Markets at Schneider Electric.

Image credit: iStock.com/MarkPiovesan