Global shocks but energy transition powers ahead – 2022 year in review

It goes without saying that 2022 has been a tumultuous year for energy worldwide, and Australia was no exception. The unprecedented suspension of the NEM in June 2022 exposed fragility in Australia’s energy market, which could not withstand the shock of high energy commodity prices caused by the Russian invasion of Ukraine. The fragility is not a surprise as Australia transitions from fossil-fuelled baseload to greater variable renewable generation. This year also saw an alignment of state and federal government objectives, as well as changes in market design and policy aiming to smooth this transition, but it will be a bumpy ride for years ahead.

Escalating pricing in energy markets continued from the second half of 2021 well into 2022. The factors for the increase in prices have been well canvassed, such as generator outages leading to a tighter supply and demand balance, increased demand from cold snaps over winter, and higher commodity gas and coal input costs. The Russian invasion of Ukraine poured fuel on the fire, so to speak, pushing up coal and gas prices globally and resulting in the cost of gas generation particularly climbing. This was important as gas generation often set the market price in periods of high demand and unavailability for coal-station. The extremely high pricing culminated in the NEM being suspended from 15 to 24 June 2022 as AEMO directed generators to provide supply. Following the suspension, prices remained relatively and only began to trend downwards toward the end of the last quarter of 2022 as supply increased and commodity prices tailed off. The energy pricing crisis presented a significant problem for the newly elected Federal Labor government. For the short term, the Federal government announced in December a $12/GJ cap on the price gas producers could sell for. More significantly, it was announced that, after the cap expires, gas prices will be essentially regulated in a similar manner to a monopoly asset. This has caused gas producers to threaten an investment strike, which, if followed through, could force the market operator to induce supply.

The energy pricing crisis has provided an impetus for the Federal and state governments to facilitate the energy transition. The Federal Government announced the $20B ‘Rewiring the Nation’ programme that will provide concessional finance for the massive transmission build needed to connect the gargantuan amount of renewable generation needed in future. States also announced many initiatives, including the NSW LTSEA tenders, Queensland’s Energy and Jobs plan to end baseload coal by 2035 and Victorian renewable storage and offshore wind targets of 6.3GW and 9GW, respectively. Victoria’s resurrection of the State Electricity Commission to create a 4GW state-owned offshore wind generator is arguably the most audacious of all state initiatives

Alongside Federal and state initiatives, 2022 saw many substantive market design proposals also attempt to smooth the bumpy road that is the energy transition. Largely to address the energy pricing crisis, the Administered Price Cap doubled to $600/MWh, expected to reduce the need for another NEM suspension in the near future. Significant medium-term market reforms continue to progress, such as Transmission and Access Reform which proposes a Congestion Relief Market to run beside the spot market, and a new Operational Security Mechanism, which is another market expected to provide system strength services as baseload generation goes offline. A review of how transmission builds are approved is also underway, which could shave one to two years off delivery schedules depending on which model is adopted. Late in the year, Australian NEM states agreed to explore a ‘Capacity Investment Scheme’, which (presumably) will provide capacity payments to renewable generators. While none of these reforms bears fruit yet, we expect these proposals to be finalised in the next year.

Looking ahead to 2023, we expect the debate around gas pricing regulation to dominate early next year. The government needs to balance returns for gas producers that incentivise investment while also lowering prices for consumers than they would have been otherwise. This is a tricky tightrope and simply highlights how it was a mistake not to introduce a domestic gas reservation policy when Gladstone LNG exports began in 2015. 

Significant market reforms are expected to work their way through the consultation process. The most politically contentious of these is the Capacity Investment Scheme, although excluding fossil-fueled generators from this scheme will improve the prospects of being agreed to by all states. Other reforms, such as Transmission and Access reform and an Operational Security Mechanism, are technocratic in nature and will likely be finalised pending industry feedback.

Cornwall Insight Australia’s Benchmark Power Curve forecasts elevated NEM spot prices over the next two to three years while gas and coal commodity prices remain at historically elevated levels along with a relatively tight supply and demand balance. We are forecasting significant intraday spreads, which could represent significant arbitrage opportunities for storage. A change in market parameters exemplifies the breadth of these intra-day spreads, with the NEM market price cap (currently $15,550/MWh) expected to rise to $21,500/MWh by FY28. 

Overall, 2022 was a year where the relationship between energy and geopolitics was brought to the fore, with the resulting impacts on energy markets and energy transitions worldwide. For Australia, 2023 is expected to be more benign than 2022 (that wouldn’t be difficult); however, it is still a question of whether our energy market can be resilient in the face of unexpected curve balls.

The above focus article is derived from our monthly Energy Executive Summary. Please contact us for further information on this service.

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